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Positioning For The Coming Rout

Thursday, May 12, 2011

Executive Summary

• What private and public debt levels are telling us
• Housing’s prospects for worsening the situation
• Why endless compound growth is impossible
• The crushing pain of a deflationary downdraft
• Predictions and conclusions for the future

Part I – Why Growth Is Dead

The rout is on.  More market weakness lies dead ahead – unless the Fed reverses course, and soon.

Eight weeks ago, on March 8, 2011, I wrote that there was a very high chance of a rout in all of the major markets – stocks, bonds, and commodities – due to the sudden disappearance of quantitative easing (QE) money at the end of June.

Since markets are supposed to be forward-looking, if the ‘rout’ thesis is correct, we’d expect the markets to begin selling off well before the last POMO. Perhaps even right about, oh, say this past week.

Following several months of remarkable price appreciation, precious metals (PMs) have been experiencing whipsaw volatility over the past 48 hours. Quite understandably, PM investors (and those thinking about becoming ones) are trying to make sense of what’s next for gold, silver, and the miners. Many of you have written in to us with the questions you’re most interested in getting insight into.

This morning, I spoke with three respected experts in the precious metals field. According to their expertise, I put a brief question to each: 

• What’s behind the current downdraft in bullion prices? (Ted Butler)
• Having lagged the increases seen in the metals, are the miners attractive here? (Frank Barbera) 
• For money looking to enter the PM market, is now a good time to enter? (John Doody)

Here is the summary of their responses:

The economic impact of the earthquake, tsunami, and ongoing Fukushima disaster on Japan’s economy, that is.

Of course, that’s not much of a surprise to readers here, but it will definitely be creeping out into the broader markets over time, and should be fully recognized in another two months or so.

The economic minister of Japan, not usually given to anything other than very measured statements, has come out with some rather bold pronouncements, including the idea that Japan may have difficulty financing all of the costs due to an already too-high level of debt.

Here’s the story:

The term “black swan,” as coined by Nassim Taleb, refers to an unusual event that nobody was expecting because such an event had never happened before. Until a black swan has been seen, they simply don’t exist; their probability is zero.

We are now in the midst of exactly what we might predict would happen when a world accustomed to sufficient net energy to drive its processes runs short of that surplus. This is our ultimate black swan.

Trained and raised in a world of ethereal numbers and ideas, today’s economists simply lack the proper framework to understand that all of the ‘rules’ they learned about monetary theory, interest rates, debt accumulation and all the rest, were not actually rules, they were temporary conditions permitted by abundant net free energy.

Brent crude oil at $124/bbl is telling us something. While the unrest in the MENA region is certainly driving some of the price gain, it is important to note that the price of Brent crude has been climbing more or less steadily since July of 2010, when it was at ~$80/bbl.

Saudi Arabia has said many times that it has lots of spare capacity and can easily fill the gap left by Libya’s temporary (or perhaps prolonged) departure. There are two problems with this view.