How Do We Protect Ourselves From a Double Dip?
Evidence is mounting that the economy still hasn't emerged from the original recession, and it seems the only safe haven left is precious metals.
Today I am going to do something really amazing. I am going to tell you that in my opinion the US economy has not entered a second recession. In fact, it never came out of the first one. Before the professional economists start telling me that the Webster's definition of a recession is two consecutive quarters of negative growth, I will simply say, "for who?" Indeed there are many Americans who have been so economically ravaged by this crisis that they have not lived through a recession, they have endured a depression. A Gallup poll that was released in April (when the Dow was 800 points higher than yesterday's close) said that 29% of the people polled didn't care what the definition of a recession was. They said they were in a depression. Add to that another 26% who said they felt they had never come out of the original recession.
Please ask yourself if it is any wonder that most Americans believe an economic downturn is still in progress. One only has to look around to see all the evidence they need to draw that conclusion. Home prices are at levels not seen since 2002 and in many parts of the country -- like Florida, California, Nevada, and Arizona -- values of homes have dropped a staggering 50%. According to the National Association of Realtors, home prices will likely drop another 10% nationwide. They also reported that if you had bought a home under the program set forth by President Obama which gave $8,500 towards the purchase of a home, and if you had put down an additional 20% towards the purchase of the home, you would now be underwater on your mortgage.
It is painfully evident to most that a full blown recession is firmly in place. I guess it's harder for the myriad of professional economists hired by the Fed to see the forest for the trees.
In my opinion there is nothing that damages the confidence of a consumer as badly as rapidly rising prices. When I am not writing, I have the dubious duty of heavy grocery shopping for my family. I have been amazed and appalled at the spike in the price of food. A pound of coffee that used to cost $2.99 now costs $6. Milk is almost $5 a gallon. Clothing has gone through the roof as cotton prices nearly doubled in 2010. The consumer's ability to buy the most basic necessities has been undermined.
While the auto industry has staged an impressive comeback, as much of its profitability has been based on layoffs as new car sales. Slower sales are not only a sign of lagging consumer confidence but also a sign of tougher times ahead. Car firms have only just begun to hire again, but that trend will die as sales plateau.
The circus that took place over raising the debt ceiling is going to make it very difficult for Ben Bernanke to institute another round of quantitative easing. He will have to be more 'stealthy' is his approach because while the FOMC remains tight-lipped, many prominent economists say another round of quantitative easing is essential to create a full recovery. His theory has seemingly been supported by last week's GDP numbers which had a revised estimate of 0.04% for the first quarter and a 1.4% estimate for the second. I have read that economists see the need for a minimum of 5% GDP to declare a robust economy.
The debt ceiling agreement has caused a call to arms for severe austerity measures, which is exactly what our already fragile economy does not need. The fact is that people are afraid and they have tightened their belts, saving every penny they can. While a healthy savings plan is the watchword of a healthy society, I'm sure the Fed had hoped Americans would practice this kind of economic restraint on somebody else's watch. What the Fed needs are the Americans spending to stimulate the economy. It certainly is a Catch-22. Add to this that today's employment numbers promise to be anemic as Cisco (CSCO) has said it would lay off 6,000 people, HSBC (HBC) expects to lay off 2,000, and state and local governments have said it is their intention to trim the payrolls by 450,000 jobs this year and next. These government cuts are already well underway.
A slowdown in the Chinese economy is usually seen as a cause of global commodity price inflation, but this coin has two sides. While China's appetite for energy and raw materials may fall, the demand for goods and services by its very large and growing middle class will drop along with it. As China has raised the interest rate in an effort to slow down the exploding growth, US exports to China have also fallen. According to the US-China Business Council, over the last decade we have seen exports to China grow from $16.2 billion to $91.9 billion -- a staggering 468% increase. However, as that rate slows it has a profound impact on thousands of American companies and their employees. General Motors (GM) is one of the two largest car firms in China along with Volkswagen. Large US corporations like Wal-Mart (WMT) and Yum Brands (YUM) rely heavily on China to boost global sales. Without vibrant consumer spending in China, American companies suffer.
Unemployment creates two problems:
- People without jobs drastically curtail their spending, which ultimately affects GDP growth.
- There comes a need for tens of billions of dollars every year in government aid to keep the unemployed from becoming destitute.
That support has increased deficits and the domino effect is that cash-strapped governments need to make more spending cuts. The continued high rate of unemployment may well be the biggest challenge the economy faces.
Unemployment has worsened because people over the age of 65 continue to work as their homes -- which were once thought of as the financial base of their retirements -- have dropped so sharply. Older Americans also fear that cuts in Medicare and Social Security are inevitable, which will increase the cost of their "golden years".
The worst part of the problem is the roughly 5 million Americans that have been unemployed for over a year. Their unemployment benefits, in many cases, may have run out. The burden of their care falls to their families, friends and community organizations. To the extent that the federal or state governments can support the unemployed, the cost to run support programs increases.
Housing is considered by many economists to be the single largest drag on the American economy and the market has gotten much worse in the last three months. Whether right or wrong, the American home was the rock that families built their economic future on. It was the primary source of equity used for college educations, car purchases, and ultimately retirements. While this may once have been true, the drop in home prices wiped out the equity that many people saw as their life savings overnight. Their ability to consume was severely damaged, further harming the GDP. High mortgage payments bankrupted people who had lost their jobs or found that their incomes had stagnated. Whatever the effects have been over the last three years, they are getting progressively worse as home values drop to unprecedented lows. Sadly, there is no relief in sight because potential buyers perceive that the price erosion of a home has not come close to ending.
Conclusion: Buy Precious Metals
This all certainly paints a very bleak picture. You may rightly ask, "In which direction do I set my compass?" The answer is the same as it has always been -- follow the money. China, India, and Brazil all continue to amass large amounts of physical gold and silver. Several days ago it was reported that South Korea had bought $1 billion dollars worth of gold. Even those who are bankrupt in Greece are taking what little paper money they have and buying gold and silver.
I will continue to look for opportunities to open positions in gold and silver. While I have been amazed by the parabolic run in gold, there are a lot of people that say the metal -- which was had a target price of $1,600 an ounce -- has blown through that level and seems to have no intention of correcting. Indeed, I read several analysts report that we may see gold reaching $2,500 an ounce before it pauses. While my Instincts tell me that the probability for this is remote, my brain tells me to follow the money. As global currencies are debased and global fears continue to grow it seems that this shiny yellow metal will continue to rise.
Let us not forget its baby bother silver, which has broken the $40.04 resistance level and seems on its way to my predicted level of $55-60 by year's end. I've been told that my $55 level is ridiculous and that silver would be $100 an ounce by the year's end. So look for the iShares Silver Trust (SLV) to pull back to $38. If it does, that may be a good place to buy in. As I have already written, the levels that SPDR Gold Shares (GLD) are trading seem overbought but I see no red lights in front of it. I would stand aside until there is more certainty. I am fond of quoting Doug Kass who likes to say, "I would rather lose an opportunity than lose capital." In the meantime don't forget about the miners. There are still great opportunities in these stocks as gold and silver under the ground have continued to lag gold and silver above. Some names that continue to stand out with potential upside are Silver Wheaton (SLW), Barrick (ABX), Goldcorp (GG), and for a longer term investment US Gold (UXG).
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