Markets still moving up...

Oil rose $2.50 on Friday...to $69. Gold rose $18 to $953. The Dow was up 18 points. And the dollar fell to $1.42 per euro.

And governments are still doing the wrong thing...trying to increase demand. It's not possible...for reasons we describe below...

Well, it's August...and we're on vacation. But just because we're on vacation doesn't mean the world stops turning. It just doesn't turn quite so fast.

"Why don't you just stop writing for a while?" our mother asked this morning. She is visiting for the summer.

"I don't know how you write every day anyway. You must say the same thing..."

Richard Russell has given a Dow Theory bull market signal. When you get a signal, he says, you don't argue with it; you go with it. Stock prices are going up.

We don't doubt it. The Dow would have to clime to about 10,300 just to give us a classic 50% bounce.

But we are in a depression. We don't gamble on stocks in a depression. It's too risky. Instead, we go with the flow. And the flow over the next 10 years or so is probably going to be down.

By our reckoning the Dow hit its high in January of 2000. Adjusted for inflation it's been running downhill ever since. Investors have made nothing for their trouble. And if we're right, they won't make anything in the years ahead either. Instead, they'll have to wait until stocks are cheap again.

You know, dear reader...investing is really very simple. Buy low. Sell high.

Okay...now that we got that figured out...let's move on...

Sticking with the basics, what we notice is that stocks, bonds and commodities move in broad patterns that last for many years. Not to put too fine a point on it, but they go up and then they go down. Or vice versa. Just looking at the last 50 years, stocks were very expensive in 1966. Then, they dilly dallied around for a couple of years...and headed down. This bear market continued until August 1982. That was when BusinessWeek magazine declared that stocks were not merely ailing, they were dead: "The Death of Equities" was the cover story that month. Naturally, equities got up from their deathbed the very next month and entered the marathon. They ran for the next 18 years.

Well, you know the rest of the story as well as we do. It's not complicated. The problem is that it takes patience to see it...to understand it...and to take advantage of it. The way to make money in stocks is to buy them when they are very cheap. But you may have to wait for 15-20 years. They're not cheap towards the end of the bull cycle. Since you never know exactly when it's going to end you don't want to buy anywhere near the top. So you wait...and then stocks keep getting more and more expensive. Finally, the top arrives...and then you have to wait another decade or more until they reach bottom.

"Well, why don't your write The Daily Reckoning once every 20 years?" mother wanted to know. "Just tell them when to buy...wait 20 years...and then tell them when to sell."

But we're going to ignore our dear, sweet momma this morning. She just doesn't understand the complexity of the financial world!

For the last nine years, stocks have been going down (albeit with a major countertrend to the upside). We'll probably have to wait another few years before they are cheap enough to buy. And when the end comes, stocks will be very cheap - between 5 to 8 times earnings.

When will that day come? Probably around August 15, 2018. Don't forget to read The Daily Reckoning that day!

Stock market cycles tend to coincide, more or less, with broad trends in the credit cycle. When people borrow and spend it causes business profits to grow. The businesses then expand; they hire more people; they build more capacity.

Then, when the credit cycle turns, everything goes in the other direction. People stop borrowing and begin paying back. Sales decline. Unemployment grows. Profits fall. Credit contracts.

We are now in the early stages of a major credit contraction. This is not a pause in a credit expansion; it is a change of direction, a credit contraction with all that goes along with it - joblessness, bankruptcies, foreclosures, and so forth.

Bloomberg tells us that the numbers have already been revised - downward. "Worst recession since the Great Depression," says its headline.

It is the worst recession since the Great Depression because it's not a recession at all; it's a depression. And the government is doing its level best to make it a great one.

The key to understanding a depression - or the downswing of the credit cycle - is that demand contracts. Consumers have less to spend. For a very simple reason: they already spent it.

Listen up, because this is important. When you borrow in order to consume, what you are really doing is consuming something today that you would have normally consumed in the future. You spend money you haven't earned yet on something you're not really ready to buy. You've heard the expression, 'time is money.' That's why borrowing money is really borrowing time. Later, you have to make it up. You have pay off the debt. When you do, you take money out of current consumption; you've already consumed it!

This is what economists refer to as "demand destruction." It's what happens in a depression. People are replacing what they took from the future. They're can't consume because they've already spent their money in the last boom. Demand collapses.

We've seen that happen in the last two years. Savings rates went from zero to 7%. Sales have declined (the latest revisions show them off more than was previously thought.) Profits are shrinking.

This is, of course, a completely natural and necessary adjustment. You can't take things from the future without putting them back eventually. The future won't stand for it. But the feds, in their benighted confusion, fight the problem like a farmer who plows backwards to fool the crows. They think the problem is too little demand. So, they try to add demand...with tax cuts...spending programs...low rates...easy credit...cash for clunkers and other fixes. What do these policies achieve? Do they really increase demand? No, they can't do that...that would require a richer population with more money to spend. What they try to do is to move demand forward.

The problem, of course, is that too much demand has already been moved forward. But they're nevertheless trying to steal even more of it...taking away demand that would normally show up two, three, four...ten years from now. That car that you might buy next year, for example. With the 'cash for clunkers' program, you might make the purchase now instead of waiting until you actually have the money. Or, that new parking lot behind the town hall. We won't really need it for a few years, but heck, if they're giving away money now... Or how about that trip to Europe? With a big tax rebate check, you might decide to take it on your 20th wedding anniversary, rather than wait 'til your 25th.

Real demand increases only when real wages increase. Then, people have more purchasing power. Trying to increase demand by borrowing - or stealing - from the future is a scam at best. Even if it works now, it fails later.

Bill Bonner
for The Daily Reckoning Australia

• Krugman Warns That the Run-up in Stocks Can’t Be Justified By the Fundamentals
• What We Face Now Is a Depression
• At a Time When We Are Drowning in Debt, We Are Also Out of Money
• England Sinks Deeper into Depression in Decade of Pain
• Big Australian Resource Stocks Up 24% in 2008

The depression darkens because people are not just being laid off - their jobs are disappearing. They do not get called back to work. Instead, they stay unemployed until they run out of unemployment benefits...and then the statisticians in Washington drop them off the unemployment rolls. Currently, the first batch of those people to reach the end of their benefits came this week. Last we looked, the Pennsylvania legislature was passing a law so they could continue drawing benefits for a few weeks more.

We've mentioned John Williams and his excellent service called Shadow Government Statistics. He looks at the numbers and figures out how they are twisted and tortured...and then figures out what they would be if they were treated properly. Currently, the unemployment rate nationwide officially is almost 10%. But if you computed the unemployment numbers the way they did back in the Great Depression, Williams says one in five people are out of work. In some places the figure is as high as one in four.

In other words, the unemployment numbers are already beginning to look like those of the Great Depression. But that's true of almost all the numbers. They've all got a '30s era look to them. And if you stopped water boarding them, they'd tell a similar story. Almost all the indicators are worse than any we've seen since WWII.

Unemployment, trade, defaults, foreclosures, bankruptcies, prices, manufacturing...you name it and you have to go back to the end of WWII to find similar numbers. Of course, at the end of the war, the wartime economy shut down. Millions of people who have been in uniform...or making tanks and airplanes...were suddenly out of work. Economists thought the economy would go right back into the Great Depression. Instead, it boomed.

Those soldiers and their families had savings. They had pent up demand - they hadn't bought a new car in 10 years...they were young...they got married...they had children...they needed baby cribs and houses. We remember going to look at one of the first major suburban developments as a child - Harundale - in Maryland, built by the Levitt Company.

It was a horrible place, but you could buy a house for peanuts...on credit. And it set the pace for the suburban consumer credit expansion of the next half a century.

But what was normal for so many years is not normal any more. Now, consumers are paying off debt faster than any time since 1952. The government, however, is making up for them. Goldman may no longer be able to push more credit onto the public; but it can push one heckuva lot of debt onto the public sector. Wall Street firms helped households ruin themselves in the Bubble of 2003-2007. Now they're doing the same for the government, helping the feds raise money on a scale never seen before in human history.

As we said...no wonder they're making money. Too bad.

Bill Bonner
for The Daily Reckoning Australia

• If Americans Do Not Return to Work, There Is No Recovery
• Bad News if You Are Afraid of Inflation in Consumer Prices
• We Expect No Recovery from the Economy
• Housing and Unemployment Are Weaknesses in the U.S. Economy
• Consumer Prices are Rising at About 10% Per Year

First up is an issue that definitely affects the future of Aussie dividends: profits. You can't pay 'em out if you don't got 'em (unless you borrow 'em, which is just plain stupid). "Profit season looming as worst for 20 years," reports Lucy Battersby in today's Age. She says that analysts expect profits to be twenty percent lower than last year with "growth prospects" pretty dismal.

Maybe we're getting ahead of ourselves with the idea that Aussie companies will begin boosting dividends to attract shareholders. After all, Bloomberg reports that Aussie firms tapped the equity markets for over $90 billion in capital in the last fiscal year. It's what you do when you're rebuilding your balance sheet and paring back debt.

In fact, RBA Governor Glenn Stevens-in addition to letting everyone one know the cash rate would remain at a 49-year low of three percent-encouraged corporate Australia to boost the stability of the financial system by bolstering balance sheets (more capital, less debt). Stevens said yesterday that, "While the considerable economic policy stimulus in train around the world should support recovery, it is likely to be slow at first. For it to be durable, continued progress in restoring balance sheets is essential."

What does that mean, though? Well in the long-run it's very good! In the short-run, it means slower growth and less business investment (capital spending). That probably means either increased unemployment, or much slower growth in employment, which puts pressure on wages (not that their moving up much anyway).

Here's a story commodity punters should keep an eye. The U.S. Commodities Futures Trading Commission is thinking about new regulations that limit positions sizes on commodities contracts. The agency says it wants to reduce "excessive speculation" in the commodity markets, especially the oil market. The agency will hold hearings in August.

Well, one way of looking at oil's rise to $147 is that it was all a beat up engineered by Goldman Sachs. That's what Matt Taibbi says in his latest Rolling Stone article, "The Great American Bubble Machine." It's a claim that the oil market is heavily manipulated by speculators and that the price of oil is divorced from the laws of supply and demand in the real economy.

Taibbi's piece is worth a read. But the CFTC is barking up the wrong tree if it wants to blame high energy prices entirely on speculators. One factor in oil's rise is clearly investment demand from traders and institutions that foresee the decline of the U.S. dollar. Another factor-subject to much debate-is Peak Oil itself (that global oil production is peaking). More on that tomorrow.

For now, we'd say this is another sign of increasing government control of the markets. Some people think this is good and long overdue. Some people don't. Either way, it looks like the world we're headed to. And it looks to us like a sure sign that the U.S. government wants to have a lot more control of what you do with your money (capital controls). We reckon the oil trading will just move to London.

More about dividends. Today's Financial Review reports that Aussie investors may miss out on $7 billion in dividends this year. The report cites research from Macquarie Securities which shows that Aussie companies paid out $48.6 billion in dividends last year but are on pace to pay out just $41.5 billion this year. Companies are preserving capital.

Again, we're not sure this is a bad thing. But it does mean that if you pursue a dividend strategy, you may have to look beyond traditional sources (banks) and do your homework. We've got Kris Sayce in the trenches doing just this work now and will report on it later this month. But what else might this renewed focus on dividends mean?

Well, it might mean the debauched age of capitalism-where companies borrowed money to speculate or invest in projects for which there was no sustainable demand-is well and truly over. It might mean companies will go back to returning earnings that are not reinvested to shareholders, where they belong.

Of course, for a company to return surplus earnings back to investors it must first have those earnings. And that is no mean feat in the post-industrial global economy. So rather than relying on the market itself to generate your dividend income for you, you'll probably have to work for it (find it).

And there is the risk that common stocks may simply be the wrong asset class to own for the next ten years. That is, there is the risk that even dividend stocks are still stocks. And if stocks are in secular bear market, it won't matter how much you get paid to own them. They will appreciate very slowly, and perhaps not at all versus inflation.

And now to debt. We've run across a few articles and charts on debt that were eye-opening. Speaking of which, please keep an eye out later today for a special invitation to an event we're putting on here in Melbourne. It will be a night dedicated to discussing this very subject.

And the main point? Not only are large (and growing) household and government debt levels making life tough for Aussies, they are part of a global power shift that threatens the economic security of industrial countries like Australia. Despite its tremendous resource wealth and proximity to developing giants India and China, Australia risks drowning itself in debt.

Or, as James G. Neuger writes for Bloomberg on the eve of the G-8 summit in Italy, "The run-up in debt has hastened a power shift that is sapping the industrial world's authority to impose its economic doctrine, currency arrangements, or greenhouse gas reduction strategies. Even some G-8 officials acknowledge that the group has lost its grip on the global recession they spawned."

"The industrial world is beset by the harshest economic conditions in a lifetime: a projected U.S. budget deficit of 13.6 percent of GDP in 2009, unmatched since World War II; an annualised 14.2 percent contraction in Japanese GDP in the first quarter, also the worst since the war; in the first three months of 2009, German exports had their steepest quarterly decline since 1970 when the date were first compiled."

But is debt really a problem here in Australia? The chart below from the Bank of International Settlements (BIS) shows that it is, and a big one at that. Australian households have the highest household debt to disposable income ratios in the world, according to the BIS. Most of household debt, of course, is mortgage debt. And households are happy to take on mortgage debt as long as house prices are rising, interest rates are low, and the job market is good.

But as you can see, in markets where interest rates have risen and house prices have fallen, households have already begun seriously deleveraging, repairing their balance sheets by saving more and spending less and relying on asset appreciating a lot less. This process-as much psychological as financial-has yet to happen in Australia. We believe it will (it's one of the things we're going to discuss at the Debt Summit.)

But debt is not just a household issue. It's a pension issue too. That's because Australia has a huge portion of its pension assets in stocks. And as the world economy deleverages, assets bought with borrowed money are sold or revalued. For Australians, that means a huge write down in the value of assets held by pension funds.

Check out the chart below from the International Monetary Fund (IMF). It shows that Australia's pension assets (mostly superannuation funds) are not only about 100% of GDP (or nearly $1 trillion), it shows that the bulk of those assets are not diversified at all. Most of it's in stocks. The rest is in property (a highly leveraged sector arguable even more vulnerable to deleveraging).

Click to enlarge

What does the chart really mean? It means that it's time for a serious rethink of how you manage your retirement assets. Super...stocks...porperty...how you make, keep, and grow your wealth is a serious challenge for the future. And the accumulation of vast household, corporate, and government debt is making it even more challenging.

In fact, government debt may be the other shoe to drop. We won't get into too much detail. But we'd suggest that Australia is treading down the path to where questions about the quality of its bonds-or worst case, its fiscal solvency itself-might start to be asked.

Granted, the public debt-to-GDP ratios in Australia are modest compared to the U.S. and the U.K. And even if they grow to around 16% of GDP (as the IMF suggests they will), they will still be much lower than other places around the world. But it's the casual attitude toward accruing these long-term liabilities that worries us. And it's also the affect rising public debt has on interest rates.

The IMF puts it this way: "Doubts about fiscal solvency-the risk that governments find it more convenient to repudiate their debt or to inflate it away-could lead to an increase in the cost of borrowing. In turn, higher interest rates (and exchange rate depreciations, particularly in countries with significant borrowing in foreign currency, like most emerging economies) could further add to government debts-in some cases, resulting in 'snowballing' debt dynamics. This scenario would be deleterious for global growth."

Yes, it would be bad for growth. And a 2003 study from the Federal Reserve (cited yesterday in the Times of London) says it would also be bad for interest rates. The study concludes that "a percentage point increase in the projected deficit-to-GDP ratio raises the 10-year bond rate expected to prevail five years into the future by 20 to 40 basis points; a typical estimate is about 25 basis points."

It was referring to increased borrowing costs for the U.S. government because of rising deficit-to-GDP ratios. But in the current Credit Depression, we have no reason to believe Aussie borrowing costs wouldn't rise too with rising deficit-to-GDP ratios.

"All else equal," study author Thomas Laubach concludes, "The results of this study suggest that interest rates rise by about 25 basis points in response to a percentage point increase in the projected de_cit-to-GDP ratio, and by about 4 basis points in response to a percentage point increase in the projected debt-to-GDP ratio."

And what does it mean? "The impact would be devastating by making it punitively expensive to finance national borrowings and leading to what Tim Congdon, founder of Lombard Street Research called a 'debt explosion.' Mr. Congdon said the study illustrated the 'horrifying' consequences for leading Western economies of bailing out their banks and attempting to stimulate markets by cutting taxes and boosting public spending. He said the markets had failed to digest fully the scale of fiscal largesse."

To be sure, if the cost of refinancing public debt doubles, it's going to be particularly nasty for the U.S. and the U.K., where public debt to GDP ratios are on the rise. But what would it mean for Australia, where public debt to GDP would be smaller, but a lot larger than it is today? Stay tuned...

Dan Denning
for The Daily Reckoning Australia

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It will also be a long time before Americans return to free-spending ways. Not only do they no longer have the collateral to back up more debt, they are also growing older and wiser. Consumer spending rose 2.2% in the last quarter. But that is probably a fluke. Americans can't spend what they don't have. And they must save for long retirements...knowing that their houses and stocks could lose value at any time.

The last report we saw showed the saving rate was back towards 5% - a big jump up from zero a year ago. There is no way savings AND spending can go up at the same time.

What's more, their incomes are falling. Wages and salaries are down 1.2% over the last year. As this depression sinks in...Americans will lose more income.

USA Today opens with a cover story on "the new homeless." There's a photo of a 53-year-old man sitting in his tent. It's a "temporary situation," he says. But the tent city in Pinellas County, Florida, may be home for longer than he expects.

"Tent cities filling up with casualties of the economy,' says the headline. "Some middle-class workers with college degrees find themselves displaced by layoffs, foreclosures."

"Economy contracts 'faster than in the 1930s,'" says a headline in today's Financial Times. A research outfit is forecasting a drop in British national income of 4.3% - substantially worse than the government's guess. The reason for this new outlook is that "world trade has collapsed by more than forecast," explained an economist on the case. The report went on to forecast UK public debt at 100% of GDP.

The story is not much different in the United States. GDP is falling at a 6% annual rate. If this continues for a few years, it will make this depression worse than the Great Depression of the '30s - which hit America much harder than it did Britain (probably thanks to the forceful response of the Hoover and Roosevelt administrations).

Equity losses last year were worse than those of '29. It stands to reason that the next phase - the economic decline - will also be worse than the '30s.

By our calculation, the U.S. economy carries about $20 trillion of excess debt. Until that debt is eliminated, the idea of a healthy boom is a mirage. Getting rid of that debt either involves a long, hard period of work and sacrifice - as debts are paid down. Or, it involves something much worse.

Our guess is that the feds - who still have no idea what is going on - will choose the second solution...something much worse.

But what, exactly? We have some ideas...some guesses...stay tuned.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• Normally Small Businesses Lead the Economy Out of Recession
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• This Isn’t a Recession
• Investors Are Thinking: Inflation is Coming, But it Isn’t Here Yet
• A Funny Story About $20 Gold Coins

Does it mean that American "consumers" (so-called) are awaited momentarily in the flat-screen TV sales parlors with their credit cards fanned-out like poker hands, ready for "action?" Not too likely with massive non-performance out in cardholder-land, and half the nation's electronics inventory wending its way onto Craig's List. Are we expecting more asteroid belts of new suburbs carved in the loamy outlands of Dallas and Minneapolis, complete with new highway strips of Big Box shopping and Chuck E. Cheeses? Go to banking's intensive care unit and inquire (if you can) among the flat-lining production home- builders and the real estate investment trusts on life support when they expect to rev up the heavy equipment.

The idea that we're about to resume the insane behavior that induced the current epochal malaise of economy is so absurd it will only be heard in the faculty dining halls of the Ivy League. And if America is not picking up where it left off eighteen months ago - the orgy of spending future claims on wealth unlikely to accrue - then what is our destiny? Based on what's out there in the organs of public thinking, it seems that we don't want to think about it.

So many forces are arrayed against a return to the previous "normal" that we will be lucky, in another eighteen months, to still find ourselves speaking English and celebrating Christmas. What's "out there" is a panorama of mutually reinforcing critical problems pertaining to how we live on this continent. Like the obesity, heart disease, and diabetes that plague the public, these problems are disorders of lifestyle habits and the only possible "cure" is a comprehensive revision of lifestyle. With the onset of spring weather and the cheez doodles and monster truck rallies and NASCAR tailgate barbeques and the drive-in beer emporiums all beckoning, can the public shift its attention from these infantile preoccupations to saving its own ass?

So far, the most striking piece of the economic fiasco is the absence of any galvanizing spirit among the millions getting crushed in the tragic unwind of our relations with money. It will be interesting to see, for instance, if there is any uproar over the evolving story of Goldman Sachs' latest raid on the U.S. Treasury, after booking billions in taxpayer-funded payouts funneled through AIG, based on double-hedged credit default swaps. Such magic tricks are understandably hard to follow, but a dozen-or-so federal attorneys with a middling background in differential calculus might suss out the trail that leads from Ben Bernanke's work station to Lloyd Blankfein's cappuccino machine. Something similar may be said in regard to revelations last week of White House economic advisor Larry Summers' connection with a number of hedge funds shoveling millions into his deep pockets for showing up once a week to cheerlead their "innovations" - not to mention his shadowy visits to the Goldman Sachs gravy train even after he signed onto the Obama campaign. As long as the stock markets seem to rally - no matter what else is really going on in America - nobody will pay much attention to these disgusting irregularities.

Since it is that time of year, and I am haunting the gardening shop, one can't fail to notice the many styles of pitchforks for sale. My guess is that the current mood of public paralysis will dissolve in a blur of blood and spittle sometime between Memorial Day and July Fourth, even with NASCAR in full swing, and the mushrooming ranks of the unemployed lost in raptures of engine noise and fried cornmeal. It doesn't take too many determined, pissed-off people to create a lot of mischief in a complex society.

On the agenda in the second quarter of '09 are ominous rumblings in the oil and food sectors. Half a year of cratered oil prices have decimated the oil industry and we're driving at 100-miles-an-hour straight off a cliff into a new kind of supply crisis - even if industrial production and global exports remain moribund. So many drilling rigs are being decommissioned that the oil industry itself looks like it's preparing for its own death, investment in exploration and discovery has withered with the credit markets, and the world may never recover from the year long hiccup in oil industry activity - translation: peak oil is biting back now with a vengeance. Its peakness will look peakier and the yawning arc of depletion beyond will look steeper and pose a threat to every globalized and continental-scale enterprise in the known world.

So many dire elements are ranging around our food production system (i.e. farming), from widespread drought and water table depletion to "input" shortages (especially fertilizers) to sickness in credit availability, that we're all one bad harvest away from something that will make Pieter Bruegel-the-elder's "Triumph of Death" look like Vanity Fair's annual Oscar Party in comparison.

Barack Obama, charming as he is, had better drop his pretensions about kick-starting the old consumer economy, fire the Wall Street clowns and parasites who are running that futile exercise, and start preparing a US Lifeboat Economy aimed at reducing the scale and scope of our outlays so we can survive the coming siege of austerity. Meanwhile, I'm glad that he finally got a dog for the White House, because the President knows full well where to turn in Washington if you want some genuine love and affection.

Regards,

James Howard Kunstler
for The Daily Reckoning Australia

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The analysts were confident about valuations going forward, especially long term. Company execs swore their deals didn't need any money, while brokers and bankers alike had a gleam in their eye about the financing opportunities amid the debris - even a sense of urgency. One broker - my former business partner, actually - wondered whether the fundamentals for gold have ever been as bullish in our lives.

The answer was unambiguous. The market has answered too.

Newmont and Freeport this week filed documents in conjunction with potential underwritings by J.P. Morgan and Citigroup, in the amounts of $1.2 billion and $750 million, respectively, totaling just under $2 billion. Kinross sold UBS about $400 million worth of stock last week. Lundin's Red Back also negotiated a bought deal worth about $150 million with a group of underwriters led by Cormark Securities and BMO last week. Earlier this month, Yamana closed a $135 million share offer and borrowed $200 million, while in December, Agnico-Eagle raised some $300 million from stock issuances after borrowing $300 million a few months earlier (in September). Where's the deflation?!

The money is coming into the gold sector. The Canadian National Post reported last week that gold miners are "raising cash with ease... many generalist funds have jumped onto the precious metals bandwagon."

Many juniors have also reported financings where needed. Some are turning them away. Share issues are just too dilutive down here, and any company that doesn't need money to survive 2009 is prudent to refuse.

Asked about the ability of miners to raise cash in this environment, the analysts at the podium at the Cambridge House investment conference in Vancouver all agreed there is always funding for assets that have sound economic fundamentals. They finance themselves. In fact, in my experience, it is often better to buy the shares of companies with good assets that need cash than companies with cash and no assets, even if the latter are trading at a discount to cash breakup, and even if funding is relatively scarce. Companies with a lot of cash can sometimes get lazy and put up their feet, or insiders waste it - or even steal it, if they lack integrity. Cash itself yields nothing. It's a depreciating good, as you know. It's one thing to buy a company at below cash breakup and then break it up and keep the extra cash. It is another thing to invest in a company at cash breakup or less. We invest to earn profits.

If you want to buy cash at a discount, buy a T-bill or term deposit. Or else, you're just sharing in potential losses due to debasement, negligence, debauchery or theft. That doesn't mean you should avoid the deals that have a lot of cash - just that's not what you're investing in. You are investing either in the underlying asset, which yields profit (i.e., more cash in the future) or management's abilities.

Ultimately, sound "assets" will hold their value better than idle cash in an inflationary environment.

It is obvious that through this crisis, despite some turbulence, gold prices have held up better than just about any other asset, commodity or currency (other than dollars and yen) we may imagine. From the point of view of a gold miner, this is a very good thing. Even better is that the price of oil, a significant cost input for miners, has fallen a lot relative to gold. This is bullish for margins. Also bullish for gold miners is that the slump may have freed up capital and labor for the development of gold assets, where previous scarcity drove up capex estimates so much that some projects had to be abandoned.

The combination of strong investment demand for gold and lower input costs makes gold stocks one of the only sectors poised for any growth in operating results (i.e., earnings and cash flows) in 2009.

On the other hand, the ratio of gold prices to many of the commodities, and the averages, is at more than a 10-year extreme, and it is not sustainable. As a matter of fact, I think it could be a drag on gold prices. Gold is the only commodity challenging the resistance point in its post-March 2008 downtrend.

It looks poised to break out, and the other commodities appear to be bottoming.

However, while the extremity lasts, it could cap gold prices.

My feeling is that the gold ratios (i.e., gold prices relative to other assets, commodities and currencies) are going to ebb in the short term while commodity prices catch up a little. I continue to think that this catch-up phase will include a rally in stock prices, and a general recovery in risk appetite, even if short-lived. While it lasts, it is likely to shave a few safe-haven points off gold. It hasn't started yet.

I'm not looking for new lows in gold on this... just some backfilling and consolidation while the other commodities and assets catch up some. This could happen over the next few months. Then look out.

Regardless, however, I expect gold shares to benefit from the general return of risk appetite too.

That is, but for some ebb and flow, I expect gold shares to do well whether gold goes up or not - so long as it doesn't go down too much. As long as it holds the $800-850 level, gold shares are a buy.

It is still a buyer's market. Many gold shares are still factoring in a gold price of less than $800. But don't be hasty.

Rather, be deliberate, which means don't waver from the plan or your conviction on dips. Buy them. Try not to buy on days when everyone else is, like today, but make sure you have a shopping list and just pick away at it when you get the dip.

Investors should always wade in (and out) of their positions, rather than jumping in and out - as ole Jesse Livermore used to do. They called him the "Boy Plunger." He made big on the way up and lost big on the way down. There are lots of folks like that on Wall Street. They're big gamblers. You could say the Fed made them. They don't care about the black swan, because they believe that should they lose, they will just win again tomorrow.

Keep in mind, though, you're not buying blue chips here. Small-cap miners (and options) are extremely volatile and risky.

Remember this is for 10-20% of your financial assets - whatever you can sleep at night with. Some people can sleep with more - some can't sleep anyway. I guess the analogy doesn't apply to insomniacs, but you get the gist.

Good trading,

Ed Bugos
for The Daily Reckoning

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Remember this is nothing fancy. Bill is preparing for world depression by ruthlessly cutting back on discretionary expenses. As far as we know, he is still letting people buy him drinks. We're also trying to scrounge up a few copies of I.O.U.S.A. from our mates in the States to raffle off.

As for the rest of the affair, canapés will be on offer. But you're on your own to fill up your stomach after that. Filling up your mind will come from the scintillating conversation to be had with other DR readers. If you haven't already RSVPd, please do so by sending us a note at dr@dailyreckoning.com.au.

And now to a world full of stuff no one wants. Selling stuff you bought with borrowed money is a process that's mostly been confined to the financial markets in 2008. But now we see the behaviour migrating into the economy. At the household level, a collective sense of thrift is beginning to set in. People are selling what they don't need to raise cash.

But let's start with the financial news first. Macquarie Group (ASX:MQG) told investors yesterday that its profit fell by 43%, thanks to write downs in assets. It was the first time since going public twelve years ago the "Millionaire Factory" has reported an earnings decline. Still, the $604 million profit number was higher than what analysts were expecting ($594 million) and the stock finished up over 16.5% on the day.

In the revenue results and write downs you can see how the decline and fall of the investment banking model has hit Australian shores. MQG reported a 13% decline in fee and commission income (to a paltry $2.2 billion). Trading income fell by 14% to $722 million. The big one was the 43% decline in income from asset and equity investments.

There were some strange assets in the back rooms of the Factory. The company took over a billion dollars in write downs on its Italian mortgages and fund management assets. It did not, however, take any write downs on Macquarie Airports or Macquarie Infrastructure Group. Hmmn.

Picture the good ship Macquarie Group as something like a Noah's Ark/Pirate Ship full of a menagerie of debt-financed assets. Under Captain Allan Moss as CEO, Australia's version of Goldman Sachs sailed the high-seas of global finance, buying assets with borrowed money, bundling them into funds, and then charging retail investors fees to invest in the funds. It's the sort of business those Somali pirates who hijack oil tankers should look into. Far more lucrative.

Twelve years of collective booty and swag gave the Factory quite a collection of eccentric and fee-generating assets. Some of those assets are not ageing so well. But you'll note the company chose not to mark down the value of its infrastructure or airport funds, the two big ones.

It claims the current market value of those assets isn't what they are really worth. The book value is more accurate. In the meantime, it is throwing other less attractive assets overboard. Deck chairs...Italian mortgages...extra chickens...everything must go!

There's no doubt that asset values are likely to fall more next year and that revenues will continue to fall too. Still, the company says it will sell $15 billion in assets and then set sail, on the lookout for more acquisitions again. Garn!

It's looking to sell its margin lending book. And new CEO Nick Moore said it will securitise its motor vehicle loan book, move it off the balance sheet, and sell it off. Thus the liquidation continues in the financial world. Loss-making assets are written down or thrown overboard at...er...fire sale prices.

What's really happening, mixed metaphors aside, is that the Millionaire Factory model is giving way to deleveraging reality. In a world with falling asset values and tighter bank credit, it's harder (and much less profitable) to build a cleverly constructed portfolio of assets and generate fee income from operating them.

In the post-credit crunch world (or post-Deluvian, if you accept the nautical metaphor), you have to focus on cash, not debt. One example would be Cash Converters, a sort of Main Street Macquarie, without the debt, and substituting Italian loafers for Italian mortgages. Cash Converters buys low and sells high. It's the perfect business for the first world depression.

Cash Converters helps people turn lazy assets (guitars, mobiles, stereos, old harmonicas) into cash. And what is that but the liquidation of the consumer spending boom? Of course, most stuff isn't worth as much people think it is. When you own something, you tend to think it's worth more than everyone else.

Then you try and auction it on eBay or take it to a pawn shop or Cash Converters. There, you find that it's worth a lot less than you believed in your heart. Such is life, as Ben Cousins and Ned Kelly might say. Kris Sayce at the Australian Small Cap Investigator (whom we often call the Ned Kelly of the Old Hat Factory) has been looking at Cash Converters as an example of what he calls "Main Street Stocks."

We'll let you know what he's up to...but we think it has something to do with companies that actually do more business in a recession and increase both revenues and earnings-without relying on debt. If you have your own suggestions for "Main Street Stocks," let us know at dr@dailyreckoning.com.au

Dan Denning
for the Daily Reckoning Australia

• Is the Macquarie Model Dead?
• Were the Government’s Stress Tests a Bogus Exercise in Deception?
• Commonwealth Bank (ASX: CBA) Nearly Doubles Bad Debts Over Last Year
• Credit Markets Threaten Retail Banking, Bank Runs Next?
• You Can Never Be Sure How Fabricated Income and Earnings Are These Days