The misinformation machines of Wall Street, the Media, Government and a raft of corporate Economists are going full blast in their effort to convince the public or perhaps themselves, that all is well and the only thing that is necessary to getG-d back into his Heaven so that all will be right with the world is a measly FED rate cut. The only question now seems to be the size of that cut, whose crescendo has already reached as high as 2%. If consumer confidence and the economy are in such great shape, where does that outcry for a 2% cut in rates come from?


I have spent the last several letters explaining what interest rates are and how they work, so I will not explain them again and for those who may require a little re-education, go back and re-read my last two missives. Let me bluntly put things back into their proper perspective: A succession of rate cuts at this time would do a lot more harm than good. The inevitable result would be to push the economy into recession, leading rapidly into a world wide depression. It is my fervent hope that, in Berenanke, we have that rarest of individuals, who has both the guts to resist the tremendous pressure that is being placed on him and the knowledge to do what is right for the economy and his country, despite any threats to his personal situation.


For the last 20 years, the economy has been floating on a tidal wave of ever increasing debt and ridiculously low manipulated interest rates. Rates that were so low as to destroy their function of allocating scarce resources and the proper pricing of risk. Up until a month ago, things had gotten so far out of hand that BBB rated junk bonds were paying as little as only 2½% over risk-free treasuries; down from a high in the early 90’s of over a12% premium. I have been advising you for over 6 months now that the surest and safest investment was a long treasuries, short Junk bond spread. Don’t you wish you had listened? By the way, it is still a great trade. 

The premiums that were demanded for risk dropped so low that people with zero or even bad credit were able to get 1% interest only, $500,000, undocumented, zero down mortgages. That is how stupid people can get when you interfere with the free market to the point where proper signals no longer function to keep the market in balance. What all this nonsense did was create a completely unsustainable level of confidence throughout every nook and cranny throughout the world.From P/E ratios to ultra high inflation of both real estate prices and the level of construction of homes and offices, we managed to convince ourselves that the five year 25% compounded increase in prices and in the number of homes built would all be readily absorbed by our population increases, most of which was due to illegal immigrants. Believe it or not, the banks were issuing no documentation mortgages to people without a social security number. Well last month, like all good things, this too finally came to an end when one risk manager at Merrill woke up and decided to do his job and reduce his company’s exposure to the insanity by trying to increase the quantity and quality of the collateral on one of their loans. Suddenly the world had its eyes opened to the fact that the Emperor Had No Clothes.


For the last 20 years or so, we have slowly tossed out all previous methods of pricing and have developed a one way, “Buy the Dip” mentality. Fear was dead and buried as recent graduates with no experience, became the analysts and money management hotshots while age, experience and prudence were slowly but surely retired from the investment scene. However, eventually reality rears its ugly head and the predominately under 30 crowd, now managing most of the money are, for the first time in their lives, learning what FEAR is all about and that FEAR always trumps Greed.

For the past 200 years, market peaks coincided with P/E ratios above 15 and stock market lows were marked by P/E ratios below 8. Yet for the past 10 years, we have convinced ourselves that a new paradigm was in force and that Bull Markets started with P/Es of 18. Likewise with Dividend Yields; lows in the past coincided with yields above 8% and 2 1/2% marked overpriced stock markets. For the last 10 years, the analysts were convinced that capital gains were all that mattered and Dividend Yields below 1.5% coincided with beginnings of new Bull Markets.

Historybe damned. What do Old Historians know anyway, they are always living in the past.


I have not heard anyone even mention the fact that the world’s second largest economy has been mired in recession and deflation for nearly 17 years even though they had cut their interest rates to zero. However what did result was the creation of the carry trade and a major contributor to world inflation and a mis-pricing of risk. During that same time period, Japan tried every Keynesian governmental spending and job creation policy in the book to absolutely no avail except to increase the government’s debt load to double that of the USA on a per capita basis at an outstanding 3 times their GDP. And that is with an economy that has a huge balance of trade surplus and a personal saving rate approaching 40%. Does everyone think that there are separate laws of economics for Japan and the USA? Is that why we don’t bother to analyze what has happened to the Japanese economy and what had happened to the USA economy during the 30’s? I guess that is why history always repeats.


When this Bull Market started back in 1984 or if you prefer 1975, only 25% of the public’s, pension funds’ and insurance companies’ monies were invested in common stocks. Today, upwards of 75% are now invested in common stocks. For the last 20 years or so, money supply growth exceeded GDP growth by over 7% per year compounded. In order for the money supply to be able to grow like that, it required a tremendous amount of borrowing (read confidence) in conjunction with manipulated, below normal rates of interest. On the 17th of July, this orgy came to a screeching halt. In spite of the World’s Central Bankers best efforts, the money supply has already begun to shrink, so where will all the money come from that is necessary to fuel a continuing Bull Market? There is NO MORE MONEY, HONEY and there is no chance for the Bull Market to resume.

Record short interest is enough to fuel one last rally but not a continuing Bull Market. The talking heads can trot out all the indicators they want, but all of them are backward looking indicators. Ever increasing amounts of borrowing (read lending) are required in order to create“out of thin air” money and that can no longer happen with the increasingly tightened lending standards occurring all over the world and especially here in the good ole USA as the Congress now wants to lock the barn door, after all the horses have escaped. Naturally!


For almost five years, 25% more homes were built per year than our economy could possibly absorb and within a year, all those unoccupied unsold homes and condo’s along with a million foreclosures will be just sitting there empty, overhanging the market and driving prices down. It will take at least 10 years and 50% lower prices before they are all absorbed. Again, let me refer you back to Japan. Their, similar to ours, real estate bubble popped in 1990 and here we are 17 years later and their market is only now beginning to bottom out. Do you really believe that in real estate as well, there are separate sets of economic laws, one for us and a different set for them? (Japan is, like us, a free market democracy)


Probably, but maybe not: Although history repeats, it never does so that you can recognize it until well after the fact. More importantly, it is still not too late to mitigate the situation. If it was not for the Socialist New Deal policies, the Depression of the 1930’s would not have lasted more than three years. We know a lot more about how economics works today than we did back then, but unfortunately our politicians are not any smarter. If we once again go down the road of protectionism, anti-business and increased Government regulation, then we will be forced to suffer through another 10 to 20 year Depression. BUT HAVE WE LEARNED ANYTHING?


Although the inevitable 30% to 50% stock market correction is already locked in place, believe it or not I think there is still one more chance at a new high between now and January 2008. Remember SENTIMENT, the figures are still too damned Bearish for it to be a major Bull Market TOP just yet. Perhaps it is just wishful thinking on my part, but I am looking for a retest of the recent lows; at which time the FED will be coerced into a ½ point cut or a series of ¼ point cuts. That, in conjunction with the all time high levels of outstanding shorts should be enough to generate one last ditch HAPPY NEW YEAR orgy of buying that would push both the market and the Bullish Sentiment readings to new all time highs. At that time, there will not be one cent left to sustain the market and a 1000 point down day will soon follow.


If you have been listening, then you are already 50% in cash and 50% in Gold Bullion. If we are all lucky enough to get that last ditch Rally, will you listen this time?

That first sell-off will be so sudden and sharp that it may pull Gold down with it to my maximum low target of $550: If it does, then back up the truck and load up with Gold and Silver Bullion and their Shares. DO NOT sell your present Gold positions. Gold may not sell off, but rise instead as it increasingly acts as a safe haven.The total market capitalization for Gold shares is only around $200 Billion. It will not take all that much panic to double or triple its price.


August 27, 2008


Aubie Baltin CFA. CTA.CFP.Phd.

Palm BeachGardens Fl.