By
Tom Dyson, publisher, The Palm Beach Letter
Wednesday, December 10, 2008
Last week, the Fed took its first step in a new, more desperate tactic to fix the financial system...
Up until last week, the Fed's operations since the beginning of the credit crunch had not created any new money supply. It had been swapping troubled assets on bank balance sheets for Treasury bonds. It was taking bad loans off banks' books and giving them good loans instead.
That improves a bank's balance sheet... and strengthens the system. But it creates no additional credit. It's not inflation.
Then, last week, it took a "quantum leap," according to George Goncalves, the chief Treasury and agency strategist at Morgan Stanley.
Instead of swapping assets in the banking system, the Fed started buying them. The Fed bought $5 billion of Freddie Mac, Fannie Mae, and Federal Home Loan Bank corporate debt. The New York Fed's website says the purchases are being "financed through the creation of additional bank reserves." The Fed has finally started to create money out of thin air.
In other words, to pay for its purchases, the Fed opened new bank accounts for its commercial bank customers, struck a couple of computer keys, and filled the accounts with money. The Fed hopes the banks lend this money out. If they do, it will add credit to the marketplace... That's inflation.
The idea behind this new strategy is to help homeowners refinance their debts at lower interest rates. A purchase of $5 billion is a tiny amount for the Fed, but think of it as a test. The Fed wanted to make sure the market wouldn't flip out over this new ultra-inflationary strategy.
The market didn't flip out. And the strategy worked. The average rate on a 30-year fixed-rate mortgage fell from 5.97% to 5.53%... the largest weekly drop in 27 years.
Now that the Fed sees how successful this strategy was, we can expect the government to continue with it. This is great news if you own investments that respond well to inflation, like gold, silver, and other commodities.
First, the public is 100% sold on the idea of imminent deflation. Commodities and gold are selling at bargain prices. In the markets, it pays to bet on the underdog.
Second, there's no political resistance to inflation. The dollar is in its strongest uptrend this decade, and Treasury rates are at all-time lows. There's no reason for the government not to inflate. There's no economic penalty for running an inflationary policy. Plus, the public is demanding stimulus and bailouts right now. They're giving politicians the green light to create money.
Finally, over $8 trillion is sitting on the sidelines in money market accounts and short-term Treasuries. Meanwhile, some unknown trillions have disappeared from the world's supply of assets in the credit crunch. When the supply of money and credit expand in relation to the supply of goods and services, you get inflation.
The easiest way to bet on inflation is with an exchange-traded fund like GDX. It's an index of the biggest gold-mining stocks. If the stock market rallies at the same time gold rallies – which should happen when inflation hits – GDX will rise like a rocket.
It's hard to find a group of stocks that has suffered more this year than the companies that design and build roads, bridges, refineries, power plants, and pipelines. Recession fears sent these stocks down more than 75% from their summer highs.
But these beaten-down builders have the government on their side. And they have huge potential to climb higher if the market enters "rally mode." News of Obama's big spending plans sent our featured stock, Shaw Group (SGR), up 21% in a week.
But there's a problem with this trade... It seems too obvious. If you explained it to your average Christmas party guest, he'd nod his head in agreement. The best trades are usually the ones that make the average party guest recoil in disgust.
Then again, sometimes the government throws so much money at an asset class that "obvious" trades are big winners. Shaw Group is rallying... other major infrastructure builders like Fluor (FLR), Chicago Bridge (CBI), URS Corp (URS), and Jacobs Engineering (JEC) are doing the same. We'll keep an eye on this "obvious" trade. Right now, it's a winner.
Most investment analysts also think the massive injections of money by the government have to create inflation and higher interest rates. That is likely true... eventually. But you can go broke betting on that before it arrives.
This report generates more reaction in the stock, currency, and bond markets than any other regular economic report. It's because unemployment is such a political issue. The market knows this report directly influences the Fed's policy...
I can't believe it, but it's true. Things don't change. When Asia is the cheapest it's been in history, everyone stares at their shoes. Then, once it's up 100% in a year, everyone wants in...
Will the Government Confiscate My Gold? By Chris WeberThursday, December 4, 2008
Gold is no longer regarded as money in any legal sense. Almost no one has even seen or held a gold coin, or certainly less than 5% of the population. Since 1933, money is whatever paper value either the market says it is or the government says it is. There is no more legal tie to gold.
