Saturday, August 30, 2008

Michael Yon: Making the Transition from Iraq to AfPak

30 August 2008

I blogged earlier about Michael Yon on April 16, 2008.

Mr. Yon is a retired US special forces soldier who has been functioning as a (rare) independent embedded journalist in Iraq and Afghanistan since December 2004.

In an interview, Mr. Yon said that when he first went to Iraq, “I knew we were losing the war,” and that “it was worse than the news was portraying.”

Mr. Yon was somewhat surprised upon returning to Iraq in 2006 to find morale quite high among American troops in Iraq, though the need for the later troop surge was then evident (for example, single soldiers were manning guard posts in volatile locations such as Fallujah and Basra). Nonetheless, he sensed a shift in momentum at that time, as soldiers on the ground were increasingly optimistic and in good spirits.

Mr. Yon was among the first to describe the turning tide in Iraq (well articulated in his April 11, 2008 Wall Street Journal editorial), which is now quite evident. He frankly described repeated and abysmal policy missteps on the part of US Command prior to the arrival of General David Petraeus (who appears to have systematically remedied these grievous strategic transgressions). But Yon was one of the first to perceive that the tactical errors of the insurgent forces (including in particular the emerging al Qaeda presence) were greater still. That is, the insurgents so greatly alienated the local population that the sympathies of the people (particularly the Sunni minority, as I read events) shifted strongly toward the American and allied forces (who under General Petraeus had initiated a dispersed relationship-building strategy with the local population).

Interestingly, Mr. Yon has concluded that his job in Iraq is now done, and, via a sojourn in Nepal, he is settling in to report independently from Afghanistan and Pakistan (which he refers to in shorthand as "AfPak").

Mr. Yon describes the Afghan conflict as now "coming at our windshield at 100 miles per hour."

My guess is, Mr. Yon will be providing the same kind of independent and insightful reporting on the Afghan-Pakistani conflict that he produced in Iraq.

The effort of reporting independently from the front lines costs him several hundred thousand dollars per year, and he is funded only by book sales and donations.

My advice - help this guy out.

We have bought the book (Moment of Truth in Iraq).

You can do the same, or you may donate here.

Click here for Mr. Yon's overview of the new AfPak mission, "Hurricane Afghanistan."

Click here for Mr. Yon's independent website.

Click here for Mr. Yon's dispatches by series.

Click here for Mr. Yon's January 21, 2008 New York Times interview: "Frontline Blogger Covers War in Iraq With a Soldier’s Eyes."

Click here for Mr. Yon's April 11, 2008 WSJ editorial ("Let's Surge Some More").

Click here for Mr. Yon's three-part 2006 series on the Afghan Conflict, "The Perfect Evil."

Bruce Willis announced a plan to produce a movie based on Mr. Yon's work in Iraq in 2005. I have not been able to find any reference more recent than this story in The Times Online.

On May 2, 2005, Mr. Yon photographed U.S. Army Major Mark Bieger cradling an Iraqi girl wounded by shrapnel from a car bomb. Major Bieger tried to bring the girl to an American hospital to receive treatment but she died on the helicopter ride. The photo was submitted to TIME magazine; it was subsequently selected by TIME website viewers as the top photo of 2005, receiving 66% of the vote (source: Wikipedia).

Mr. Yon's mailing address follows (checked daily; this is the best way to reach him):

Michael Yon
P.O. Box 5553
Winter Haven, FL 33880

Prepare to have your mind expanded.


Monday, August 11, 2008

There is a Tsunami Coming in Gold

11 August 2008 (updated 13, 15, 17 & 28 August 2008 & 20 August 2011)

I could say much more about the topic of gold's recent sell-off and dramatic plunge below its 200-day and (bull market-defining) 65-week moving averages, but just allow me to say this.

With gold trading today in the $820.00 range, and silver in the $14.60 range, no investor could possibly go wrong buying either at today's prices.

There is a tsunami coming in gold.

The same goes for the gold and silver miners.

There is a fantasy that the US credit and accounting problems have been fixed, and that they will be mostly in the background by September.

Not true, as Nouriel Roubini has demonstrated. You might also have gleaned this by reading my recent post on "Wimpy's Rule." (If one borrows hamburgers and chooses never to pay back the lenders, then every borrowed hamburger is a legitimate addition to your profit statement - thus, the more you borrow without plan of repayment, the greater your profit - according to FASB standards - and if you are not entirely embarrassed to be behaving like an out-and-out bum!)

Both gold and silver will double from these levels in a fairly moderate period of time (1 - 3 years, and I favour the shorter side of the time frame).

I think the above chart might work out as a head-and-shoulders bottom. Of course, I could also be wrong.... Tune in tomorrow for more information!

10:20 P.M.: Here is an end-of-day note.

Based on several technical indicators, gold is at its weakest point ever in the 8-year history of its bull market. Specifically, the MACD (moving average convergence-divergence) oscillator is extremely low, meaning that the price is further below its 50 and 200-day moving averages than it has ever been during the past 8 years. The same is true for the relative strength indicator (RSI). Click on the chart below for more details:

To be honest, I didn't believe that the gold price would ever be this weak again. But, here we are. In bull markets, strong runs are often preceded by hard selling. By my analysis, we have just witnessed the hardest selling that has occurred in the gold market in 8 years. I think the implications for gold bulls are clear... this is the kind of move that precedes a doubling in price.

Unless you believe that the crumbling US financial system has been repaired by bailing out the investment banks and the GSEs (Fannie Mae and Freddie Mac) with taxpayer money, this is a buy signal.

If you believe that a $2 trillion credit loss unwinding process is not yet all over - this is a buy signal.

In brief, this is the strongest buy signal in gold that we have seen in the past 8 years. It probably portends a powerful upward move when the selling (by short-term focussed investors) is over.... And, that could be soon!

Oh, and I keep forgetting to add, with global recession on the horizon, energy and materials costs are now in decline. This portends lowered costs of production for gold and silver miners, so the fundamentals are now looking stronger still for this sector....

13 August 2008: With gold now slipping below $800.00, it remains its most oversold of the entire 8-year bull market. The current price is so far out of line with the fundamentals, comment does not seem to be required. I will say this - this is what Tsunamis do. The sea level falls. It might bounce back, then fall some more. But we know why. It is because the massive wave is coming. The decline is temporary, and its severity is a clue to the magnitude of the incoming wave. Gold is making ready for something huge.

Remember that early August through early February is seasonally the strongest period for gold. Current prices are a giveaway, plain and simple. I honestly can't comprehend who would be selling at these prices, but the buyers will certainly be rewarded in short order. This is a reward package that should have a short waiting period!

15 & 17 August 2008: There is now much talk that gold could be entering a major correction phase, with a lull or end in its bull market. In fact, I am among those who believe that such an event could occur. Gold corrected 50% in the 1970s bull market, from $200 to $100 per ounce, over a period of about 1-1/2 years. Of course, in the world of investments, anything can happen. The current 25% correction is on the order of gold'
s 26% correction in May 2006. Neither correction is anywhere on the scale of the 50% correction of the mid-1970s.

However, I do not believe that gold is due for a correction of significantly greater than the current magnitude here and now. The truth is, given global fundamentals, the run-up in gold has so far been quite modest. If there is to be a major correction, in my view it will have to occur from a far higher and more vigorous ("overbought") top than it has so far seen. I do not know why gold has fallen so far so fast at this time, though seasonal weakness remains an obvious factor. We have burned through a series of stops, forcing further selling. But I don't see the kind of volume at these levels that suggests a capitulation. The present trend is not in my view of the kind that would presage such a primary (50%) correction.

However, continued or strengthened selling at these levels would indicate that something untoward is afoot, so watchfulness should certainly be exercised!

At risk of belabouring the obvious, gold's forced selling low today of $775.00 to $777.70 (I find different figures from different sources) brings us back to a major trendline established in July 2005. I don't have charting tools to draw the line, but if you click on and enlarge the chart below, you will see that gold is presently sitting exactly on this trendline. It is no secret that investment vehicles have a habit of returning to such trendlines, and the function seems to be to wash out speculators who have overextended themselves through margin borrowing or other forms of leverage (such holders do not provide firm enough support for strong bull moves). Certainly, gold could continue to hold "low" to this trendline as a base for a period of time, as it did in 2005 and 2007, though to my eyes, the present steep descent with multiple gaps doesn't look like the kind of downtrend that is likely to persist for long.

James Turk, of GoldMoney, notes that while there is forced selling on the "paper market," physical gold and silver are presently unavailable from essentially all sellers, due to a dramatic spike in demand for the precious metals as a physical investment product. He indicates that this kind of physical demand is likely to push the price sharply higher when the now presumably-forced paper selling (due to leverage and margin) exhausts itself - as all such trends eventually do.

Mr. Turk adds, "To give you a true picture of just how bad inflation has become, here is what John Williams of Shadow Government Statistics reports in his latest newsletter: 'The SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, rose to a 28-year high of roughly 13.4% in July, up from 12.6% in June.' It's no wonder that the demand for precious metal coins and small bars is so strong!"

Note that the present link will take you to Mr. Turk's current market commentary. You may then have to search the site for an article with this title: "A Fabrication Bottleneck or Something More."

Fortunately, I have also found an illustration of that 2005-2008 trendline in the gold price in Mr. Turk's above-cited article, illustrated here:
Now, if the next move in gold sees a dramatic spike top, then a 40-50% retraction would not constitute atypical bull market behaviour. It is now easy to forget (and I have written previously) that Dell Computer was the best performer of the 1990s tech stock bull market, soaring 27,500% from 21.7 cents per share ($0.217) in mid-1993 to $59.69 per share in early 2000.

Note that Dell first fell 72% in the beginning of 1993 (from 77.9 to 21.7 cents per share) before taking off from its $0.217 low. However, Dell never looked back over the next 7 years, until finally blowing out at its $59.69 peak price in 2000 - except, if you look closely, for its 50% pullback from $1.54 to $0.72 in 1995-96. This example is the kind of greater correction that might still be coming in gold, but again - in my opinion - not from gold's current levels!

It is no secret to seasoned bull market investors that when spike lows of this kind exhaust themselves to confirm a trend of greater than 3 years' duration, one very likely outcome is the emergence of a new and steeper uptrend. That is, my thinking is that from here, gold is most likely to move up more steeply than it has already done, and that could take us breathtakingly higher over a modest time frame. This is what I mean by a "tsunami" in gold. And of course, it would not be unusual to see dramatic subsidence in price levels after the tsunami strikes (as was the case in Dell's share prince in 1995-96, as previously discussed). But this is exactly what I mean. In bull markets, dramatic pullbacks follow tsunamis. They do not occur following gradual upward surges, such as the gold bull market has seen so far.

What will trigger the tsunami, and how will we recognize its peak?

For a moment, let's follow the tsunami analogy further, with this description from Wikipedia:

"There is often no advance warning of an approaching tsunami. However, since earthquakes are often a cause of tsunami, any earthquake occurring near a body of water may generate a tsunami if it occurs at shallow depth, is of moderate or high magnitude, and the water volume and depth is sufficient.

"If the first part of a tsunami to reach land is a trough (draw back) rather than a crest of the wave, the water along the shoreline may recede dramatically, exposing areas that are normally always submerged. This can serve as an advance warning of the approaching tsunami which will rush in faster than it is possible to run. If a person is in a coastal area where the sea suddenly draws back (many survivors report an accompanying sucking sound), their only real chance of survival is to run for high ground or seek the high floors of high rise buildings."

The following photo illustrates the maximum "trough" (dramatic drop in sea level) prior to the impact of the
third and strongest tsunami wave at Kata Noi Beach, Phuket, Thailand on December 26, 2004 (sea visible in the right corner).

May I suggest that the trigger - or "earthquake" - has already occurred - and that is the $2 trillion (or more...) US credit meltdown that is now in process. My best guess is that the cresting wave of the tsunami will first be spotted on the horizon when the easy answers (such as, "the credit crisis will be mostly over by September") begin to lose credibility in an environment of recurring financial market instability. The concern is most likely to be the growing perception that the problem is a bigger one than even the world's still-richest economy can master (which in fact it is).

Here is just one current piece of data critical to the continued pressure on US financial markets. Delinquencies on both mortgage loans and loans generally more than doubled in 2007, As Doug Casey at Casey Research has demonstrated (see following chart).

Given such developments, the gold market could soar to irrational heights (it has certainly not yet done so, particularly when the gold price is viewed in inflation-adjusted terms). Gold could then pull back from an irrationally high price level by a factor of 50% or so. But again, that is for another time, and as I see it, certainly not for the current correction from the still very modest peak gold price level of 2008.

With the US dollar's surge over the past month from $71.31 to $77.15 on the US Dollar Index (USDX), it has crossed my mind that this dance above the 200-day moving average may constitute the greenback's "last fling" before falling further into its debt-fuelled abyss.

Now, I don't know if gold will fall below its current 3-year trendline support (trendline breaks happen all the time, and are sometimes meaningless; also, we have not yet seen a conclusive spike low in gold, suggesting that more downside is still possible next week), but current price levels do represent primary 3-year support for the current gold price. (If you look at today's closing silver price of $12.93, the same is also true in silver.)

See the chart below for an illustration of gold's "spike" low in mid-June 2006 (and note that in 2006, gold held at its 200-day moving average support level, clearly indicating that no tsunami was indicated in 2006 - the later September-October dip below the 200-day moving average was modest and brief):

Or consider gold's August 16, 2007 blow-off low, also supported by the 200-day moving average:

Now look at the spike down of August 15, 2008. The current fall of $214.60 (21.6%) from July 15, 2008 through August 15, 2008 is unprecedented in the current gold bull market, in that the drop did not occur from the March 2008 peak price level, and the price has plunged through the presumed strong support of the 200-day moving average. Of course, the harder selling now occurring may also require a more definitive "blow-off" spike at its bottom than those we saw in 2006 or 2007. But we are certainly nearer the bottom than the top of the present move, as is dramatically illustrated below:

Relative to its 200-day moving average, gold has never been this cheap during its entire 2001-2008 bull market, as Adam Hamilton's chart (below) illustrates quite dramatically (the red line is the "relative" gold price). Be sure to subscribe to Mr. Hamilton's exemplary service in order to access this and other insight-generating technical charts!)

I will say this in conclusion. We bought both physical gold and physical silver today (in a 60/40 ratio) from Kitco (through their Canadian dollar pool account). And if the price falls further, say to the level of gold's 2006 peak of $730.40, we will obviously buy some more at even better prices. As they say, bargains like this don't come along every day. Think about it - a return to the levels of just last March would represent a 50% gain on our purchase today (this due to silver's extreme 42.6% retraction, moreso than to gold's 24.8% pullback, each from their March highs of $21.44 and $1033.90 respectively).

I've been around too long to expect us to recover gold's March 2008 price levels instantaneously. However, if there is in fact a tsunami coming, we will then be looking back from a price point far higher than that achieved in March of this year!

28 August 2008: Enough time has passed to confirm an apparent head-and-shoulders bottom taking shape in the gold price, as I initially speculated on August 11. In any case, this is Clive Maund's view, and he is on target in his technical analyses more often than not.

Click here for Mr. Maund's full review of the technical charts.

And while you're at it, check Pamela and Mary Ann Aden's recent analysis here.

The Adens conclude that the critical 65-week moving average is continuing to provide strong support (following a brief plunge lower (which is the point where we added to our gold and silver position).

15 September 2008: Much has happened since posting this August 11-28, 2008 blog entry. Gold has clearly fallen below its 65-week moving average bull market support level (though the 20-month moving average, watched by some, is holding so far). There is wide sentiment that the gold bull market, if not over, has at least entered a bear phase - though not all think so. The gold investment conferences are again as deserted as they were during the vicious 21-year 1980-2001 precious metals bear market. It is presently as though the gold bull market never happened - despite gold's being, even here - at three times its 2001 price level! My updated thoughts on the gold tsunami (it is still coming) are presented here.

20 August2011:
I suppose it goes without saying. The gold tsunami is now here. This is it.

Hope you are making the best of it.

Ride the wave!

My gold tsunami posts are as follows:

There Is a Tsunami Coming in Gold

Gold Tsunami II: Anthropomorphizing Gold

Gold: Safe Haven in the Approaching Perfect Storm

Gold Tsunami III: James Kunstler's Use of the Analogy

Bond Prices: The Seismic Shift That Triggers the Gold Tsunami (IV)

Gold Tsunami V: The $23 Trillion Bailout... and Counting

Gold Tsunami VI: Looking for Patterns in Gold Price Advances

Gold Tsunami VII: This Is It

Gold Tsunami VIII: Gold Mining Stocks Now Participating

Sunday, August 10, 2008

Rising Profits in FASB Wonderland... or Wimpy's Rule

10 August 2008

This new development seems so important that I simply must comment on it.

To my knowledge, two US companies - and probably many more - are now reporting blowout quarterly profits using a mark-to-market accounting rule under US Financial Accounting Standards Board (FASB) guidelines.

When I explain this to you, I don't think you're going to believe me. But it's actually not that complicated. It is loony. It's crazy. But it's not that complicated.

Radian Group is a bond and mortgage insurer. Their business is not going well, due to their exposure to collapsing assets. However, in May 2008, this company reported a quarterly profit of $195 million due to a single "fortunate" factor - the declining probability that the company will be able to pay interest or principle on its outstanding financial obligations.

Yes, you heard that right.

Radian is affected by the mark to market rule.

Wikipedia states: "In accounting and finance, mark to market is the act of assigning a value to a position held in a financial instrument based on the current market price for that instrument or similar instruments. For example, the final value of a futures contract that expires in 9 months will not be known until it expires. If it is marked to market, for accounting purposes it is assigned the value that it would fetch in the open market currently."

(Holman Jenkins, in the Wall Street Journal, refers to mark to market rules as a "fabulous failure." Read here for more information. And pay attention to the name Nouriel Roubini as you read the article, as Mr. Roubini is tallying probable credit losses in the current financial meltdown, with a present estimate in the $2 trillion range... and counting. Visit Nouriel Roubini's Global Economonitor blog here.)

The same principle (marking to market), of course, applies to the kinds of toxic assets that are exploding all over Wall Street these days, collateralized debt obligations, mortgage-backed securities, off-balance sheet structured investment vehicles, and so on - including, let us not forget, the financial instruments brought to you by the commercial banks, investment banks, financial services companies and insurers who have been holding these fantasy-based products as assets.

The purpose of the mark to market rule is to protect investors, who have a right to know what the assets of the companies they invest in are actually worth - for example, Merrill Lynch (whose assets have just taken a $24 billion writedown), to take a recent case in point.

Here's the latest FASB accounting trick for you, however.

Under these rules, companies whose financial liabilities and obligations are growing more rapidly than their income and assets now have a right to mark their own corporate bonds to market.

Yes, you heard me right!

If the company believes its bonds are declining in value because they probably won't actually be able to make payments on them, FASB rules allow the company to lower its liabilities by marking its own bonds to market prices.

Yes, Alice, you also heard that correctly; and, welcome to Wonderland!

Let's say, for example only, that Radian Group (or any other company operating under FASB rules) has issued $100 million in bonds to raise funds for the company's operations. This means that Radian is obliged to pay back all $100 million plus interest. So, the company actually owes $100 million plus something more in interest to trusting investors who have purchased their bonds.

Now, following FASB rules, Radian takes a look at the market value of the bonds that it issued.

Let's say that the market doesn't like Radian's balance sheet, due to the massive increase in payouts for faulty bonds and mortgages that they have insured in the course of doing business. For the sake of example only, let's say that the market is now valuing this particular set of bonds at $70 million.

Radian now processes that information on its balance sheet as follows:

Previously, the company was obliged to pay $100 million plus interest on this bond issue. But in the real world of the market, nobody believes that Radian will be able to repay bond holders fully, though perhaps 70% might be believed to be recoverable if the bonds were redeemed in this particular quarter (their value could fall further as the company continues to bleed assets).

Again, for the sake of example, Radian would now declare an obligation of only $70 million on the $100 million bond issue. The company "plans to pay" only what it can, due to its fully acknowledged financial distress. This now brings the $30 million decline in the value of the bond issue to the asset side of the ledger, and this is declarable on the profit statement in the quarter in which this particular FASB-approved financial manipulation is executed!!!

Again, in May 2008, Radian was carrying a quarterly loss of $215 million in their tanking bond and mortgage insurance business. However, based on the mark to market principle, they decided that in all probability (as recognized by the market in corporate bonds) they aren't ever going to pay $410 million of their obligations - money they borrowed from and originally promised to repay to investors.

As Wimpy in the Popeye cartoons was known to state, "I would gladly pay you Tuesday for a hamburger today."

Voila! The $215 million loss metamorphoses into a $195 million accounting gain, and Radian gets to declare a large profit for the simple reason that they now publicly plan to default on their obligations to their own bondholders!

Let me tell you, Radian Group is not unique. Only last week, Ambac Financial Group used the same rule to declare a $5.9 billion single-quarter gain!

Again, this means that Ambac has decided that the market expects it to "stiff" its bondholders to the tune of $5.9 billion - and, since the company has no plan to repay its financial obligations - they can take back the money they formerly owed and declare a hefty profit for their shareholders.

Bill Fleckenstein says it like this: "If you're capable of ruining your own credit, you can book that as a profit, or so FASB would have us believe."

(I hope you are now visualizing Wimpy clearly as he puts down his most recent in a succession of hamburgers for which he has no plan ever to make repayment, whether this Tuesday or next, or any other Tuesday of any future week!)

I could say more, but why add insult to injury?

Let me summarize:

Under FASB accounting rules, companies whose finances are so bad that they believe the market has no expectation they will ever repay their financial obligations are permitted to declare the money they no longer plan to pay as a single quarter profit in the quarter they decide not to repay their bondholders.

Or, if you will, under FASB rules, Wimpy is permitted to declare all the hamburgers he has ever eaten as profit derived from his business (in his case, and not so differently from our other examples, the business of being a bum) in the quarter in which he decides that no matter how many Tuesdays stretch out on the road of life before him, he will never repay anyone on any of those Tuesdays forever more.

Let's just call this Wimpy's accounting rule, shall we?

Doesn't Make Sense

9 August 2008

Howard Marks is the Chairman of Oaktree Capital.

I think he's got it exactly right.

Example: Chuck Prince, the former CEO of Citigroup, lost his job in 2007 for following the crowd and wasting tens of billions of dollars of investors' money gaining "market share" in a worthless market ("unconventional" - read undercapitalized - or uncapitalized - mortgages).

Mr. Marks' point: Had Mr. Prince done the right thing and sat out the rush of the lemmings into valueless mortgage-backed assets, he would not have lost his job in 2007 - he would have lost his job sooner!

What? Why?

For losing so-called market share to the other lemmings.

Mr. Marks refers to this phenomenon in American financial markets as "short-termism." Targets are set and evaluated quarterly, so there are no long-term objectives - such as "gradually building value." Results must be instantaneous or they are disregarded.

The other problem Mr. Marks sees is the compensation of executives based on their ability to jettison research & development efforts and to pillage the pipeline of future sales in order to "maximize shareholder value" one quarter at a time - while collecting disproportionate pay and option packages - until of course, London Bridge comes falling down.

Anyway, why take it from me?

Read it here - the article is a PDF document on Oak Tree Capital's website.

Rating: five stars - must read!

Oh - by the way, Niall Ferguson says that a local (financial) squall in the United States could grow into a global tempest. Read about it here. (Linked through Finance Trends Matter - a great source for the best of the best stories each week.)