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On the days that I don't publish, like today, you receive
Bill Bonner's DAILY RECKONING. This will help you to keep
pace with the changes in the markets. Bonner and I agree
on most things in the field of economics, so the two letters
reinforce each other.
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Gold Does Its Job
THE DAILY RECKONING
PARIS, FRANCE
TUESDAY, 5 FEBRUARY 2002
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*** Dow falls...but Nikkei still leads the race...
*** Ebbers, once one of America's richest...now one of
America's poorest...
*** Everybody gets Enron cash but us...losses become
profits...UAL and the "B" word...and more!...
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The Dow slipped 220 points yesterday. But even
that was not enough to put it ahead of its fleet-of-foot
Japanese cousin. The Nikkei Dow is still leading in the
race to the bottom, 9475 compared to 9687.
The Wall Street Journal reports that Amazon may
not have enough cash to continue operations. The stock
fell $1.20.
Also in the WSJ was news that TYCO had spent $8
billion on secret acquisitions. TYCO stock dropped
$2.13.
And, according to the New York Times, Bernard
Ebbers of WorldCom owes $92 million more than his stock
is worth. Investors sold the stock, eager to unload
before Ebbers.
Ebbers has done something truly remarkable. In
1999, Ebbers was one of America's richest men. His
WorldCom shares were worth $1 billion. Since then, the
stock has fallen 84%. Now, he's one of America's poorest
men. It is a rare man who can carry both distinctions
with such grace.
But Ebbers only did what everyone else does - he
tapped his equity when he had a lot of it...borrowing
nearly $200 million against his WorldCom shares. Thus
has Mr. Ebbers provided the world with an exposition on
what happens when a bubble economy deflates. The
"equity" disappears...but the debt remains.
How will we know when the bottom is finally
reached? Look for Ebbers' picture among the Forbes'
gallery of "America's Poorest People"...or Enron on the
new list of the "Misfortune 500."
And here's a note from my friend Rick Ackerman:
"This one's a doozy, Bill. Seems Nasdaq 100
companies reported $82M in losses in SEC filings for Q1-
3 2001, while claiming $19.1 billion in combined profits
to shareholders, based on 'pro forma' methods.
"On a local note," Rick continues, "the word
bankruptcy is getting tossed around in connection with
UAL, a huge Denver employer. The airline supposedly is
losing $10 million per day, but who knows? UAL's
supposed answer will be to 'enhance' revenues by raising
fares. They are already the priciest carrier for
business and last-minute fares, so this latest
inspiration could be a very efficient way to commit
suicide."
"American Enterprises' Accounting Suspect," says a
headline in today's Figaro. All over the world, people
are wondering about America's numbers. More below...
Eric, what's the news from Wall Street?
******
Eric Fry out on the left coast...
- Palm Springs was a balmy 75 yesterday. But the Dow
Jones Industrial Average was an ice-cold 9,687 - down
220 points from Friday's close. Winter on Wall Street is
becoming quite frosty and there's really nowhere to
hide.
- The Nasdaq bested the Dow's decline with a 3% plunge
to 1,855. Concerns about corporate bookkeeping captured
the headlines and sent investors scurrying for the
exists faster than Kenneth Lay from a Congressional
hearing.
- The former Enron CEO did not approve of the
"prosecutorial" tone that the hearings had adopted.
Lay's got a point; Congress really should not get the
chance to hang him until he has had a chance to finish
hanging himself. "Blowing off" a Congressional hearing
is a pretty good start.
- The financial Nor'easter blowing west from Wall Street
is creating an economic ice storm for which few folks
seem prepared. Consumer confidence jumped again in
January. But the latest numbers might be as good as they
get for a while. Confidence and the resultant consumer
spending might wither in a hurry in the face of a
falling stock market and a barrage of headlines about
dishonest corporate accounting.
- I'm here in the California desert this week to attend
the latest gathering of the Supper Club - the small
group of folks who get together about four times a year
to examine select venture capital opportunities. Out
here in the pleasant 70-degree winter weather, I am
reminded of the great majority of American investors who
are wholly unprepared for the harsh economic winter that
might be headed our way. (Imagine Boy Scouts with day-
packs setting out to scale Mt. Everest).
- Financially speaking, the nation is prepared for only
one outcome - a Palm Springs winter. We've donned our
swimsuits, slapped on our tanning oil, plopped down on a
lawn chair and started looking around for someone to
fetch us a pina colada.
- How else would you describe a populace that saves no
money, borrows more than $1 billion a day of foreign
capital and considers Intel a great buy at 50 times
earnings?
- Yet, miraculously for us Americans, in recent years
there has been almost no act of financial imprudence
that has not produced a favorable outcome. Whatever we
do, it just seems to work out.
- Therefore, why shouldn't we assume that the weather
will be 75 degrees again tomorrow, just like it was the
day before?
- But what if the economic springtime in America starts
to look like a New York winter, or worse, a Fargo, North
Dakota winter? Is anyone ready for that?
- Meanwhile, the shifting financial climate is blowing a
favorable wind in gold's direction. The ice block
encasing Mr. Gold Market is thawing. He looks much like
he did 20 years ago, except for the ghostly pallor that
results from two decades on ice. But the color is slowly
returning to his cheeks.
- The yellow metal bounced more than 1% yesterday to an
8-month high. Are we witnessing the little rally that
could?
- Okay, I'm confused. During the "bubble zone" bull
market of the late 1990s no one cared about how
companies accounted for their profits or losses. In fact
no one cared about profits or losses. Who can forget
"eyeballs," "hits" and "page views?"
- Accounting did not matter...except, of course,
accounting for personal capital gains. Then suddenly,
for a few days last month, accounting was the only thing
that mattered to investors as they pummeled the shares
of any company suspected of presenting less than the
honest truth about their operational performance. Then,
last week, investors decided to put all that nastiness
behind them. Forgive and forget seemed became the
guiding principle. And then came yesterday...Th-whack!
The whip came down on all the integrity-challenged
names.
- Tyco, IBM and GE all suffered to varying degrees. But
Irish drugmaker Elan suffered the most, losing more than
50% of its value in a single day.
- These financial inquisitions are fairly brutal
affairs. But the markets will come out the other side
purified, and they will become a more honest place to
buy and sell stocks. Unfortunately, purity might not be
achieved until about Dow 6,000, but it will have been
worth the wait.
******
Back in Paris...
*** The San Jose Mercury News: "The oldest, most basic
valuation measure of stocks - the price-earnings ratio -
soared last week way beyond anything ever recorded, at
least since 1872, for the 500 largest U.S. companies."
"This ratio for the Standard & Poor 500 index hit a
staggering 60 by last Friday, as calculated by Bloomberg
News. That's twice the level it reached during the
Internet bubble of 2000 and more than three times higher
than its historic average.
"In other words, investors were willing to pay $60 a
share for every $1 a share that companies in the S&P 500
earned during the past 12 months. During the Internet
bubble, they were paying $25 a share.
"As for Nasdaq, the companies making up the index
haven't had enough earnings since last April to
calculate any ratio that makes sense. The index of the
100 largest companies on Nasdaq is showing a loss of
$145 a share for the last 12 months, according to
Bloomberg News."
*** At the peak of the bubble economy, the Nasdaq earned
$12 a share. But earnings have fallen faster than stock
prices. The 230 Silicon Valley firms that reported 4th
quarter earnings showed a combined loss of $4.3 billion,
up 9% from the previous year.
*** Republicans, Democrats, Paul Krugman...even Jesse
Jackson took money from Enron. Enron, of course, was
handing out cash like a politician, to make friends and
silence potential critics. Alas, a fat lot of good it
did. As news of the Enron payments spreads, the payees
feel obliged to attack Enron even more harshly, to prove
that they had not been "bought." And why not? Enron has
no more cash to dispense.
*** We want you to know that here at the Daily
Reckoning, we have not been bought. Of course, we would
have taken money from the company, but it was never
offered to us...
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GOLD DOES ITS JOB
by Bill Bonner
"The Japanese people themselves are reportedly buying
gold like it is going out of style, carrying it home in
bags loaded up with the stuff," writes the Mogambo Guru.
This underscores the notion that gold is the ultimate
hedge against government mismanagement. They recognize
that their own government is debasing their currency,
and they are rightfully scared. Thus, gold again
performs its job."
Gold's job is to do nothing. I have recommended it to
you in these letters at the beginning of each of the
last two years. It has not gone up. But neither has it
gone down. It has gone nowhere.
Under the circumstances, nowhere has been as good a
place for an investment to go as any. Bernie Ebbers'
stock fell 84%. Amazon is down 90%. Cisco knocked
investors for a $60 billion loss. Gold bullion, on the
other hand, is worth roughly as much today as it was 2
years ago, and in real terms, about what it was worth 20
years...or even 2000 years ago. In the Roman era it was
reported that an ounce of gold would buy a man a decent
toga with a belt. Today, an ounce of gold - at $289 -
will still probably buy a decent toga, if you can find
one.
Gold goes nowhere. It may be portable, but it is
immobile.
Paper money, on the other hand, moves. Give it a good
gush of air and it gets whipped up like trash in an
alley.
Today's letter is inspired and informed by an article
entitled "The Investment Case for Gold," found on the
website of the Tocqueville Funds. To make a long story
short, it argues that the tailwinds that have blown
paper assets forward since 1979 have already begun to
swing around. In the coming storm, the dollar and the
Dow could lose up to 85% of their value, relative to
gold.
One day to the next, it is impossible to say what will
happen to gold, the dollar or stock prices. But a chart
at the Tocqueville site shows a longer-term pattern. It
is, we imagine, a pattern imprinted on humans' hard
drive...
The chart plots the Dow against the price of gold from
1915 to 2001. From 1915 until 1926, the currents blew
the Dow up to a level that was 15 times the price of
gold. Then, in the whirlwind of a bear market and
depression, people turned their backs on paper and clung
to gold. In the financial debacle of the '30s, people
lost confidence in paper; not in the dollar, which
remained strong, but in stocks. Their distrust of stocks
was so great that it took 22 years - from 1926 to 1948 -
before the Dow began to rise against gold.
But once the trade winds got behind paper assets again,
they blew steadily for the next 17 years, until 1965. By
then, the ratio of the Dow to gold had reached nearly
30, whereas it had been below five in 1948.
Once again, after 1965, the winds changed direction and
blew so hard, the ratio of the Dow to gold fell to below
one in 1980. In that year, gold sold, briefly, for more
than $800 an ounce. The Dow at the time was only 796.
You could have bought the entire Dow for a single ounce
of gold.
You should have done so. Because never again would the
price of gold be so high and the price of stocks so low.
The Dow began its epic rise in 1982...taking it to a new
record high against gold in 1999. In that year, the
Dow/gold ratio topped out at 42.
The hot air that carried the Dow and the dollar so high
have cooled. The Dow is on its way down. The price of
gold, more than likely, is on its way up.
Why should the dollar fall against gold?
"The Enron bankruptcy, the de facto default on sovereign
debt by Argentina, and a looming financial crisis in
Japan," says the Tocqueville report, "are random but
high profile reminders of a deteriorating global credit
environment."
The lie hidden in the deepest entrails of modern central
banking is that "money" can be created out of thin air.
If the economy is growing too slowly, economists are
heard urging the central bank to "put more money" in
circulation. Of course, if more "money" could really
make people rich, the Argentines of the 1980's would
have been fabulously wealthy.
Instead, they became pathetically impoverished. How
come? Because the central bank cannot really put more
"money" in circulation. All it can do is circulate more
of what appears to be money...paper currency or
credit...in order to make people feel that they are
richer than they really are. Under ideal conditions, the
mock money causes people to spend and invest a little
more freely...and gives a sluggish economy a boost.
But people cannot really spend money they do not have.
Money must represent real wealth...real resources...
or it has no meaning. Printing extra bills does not
increase the amount of real resources available. So,
handing out the extra cash and credit is a kind of
deceit...which is welcomed by almost everyone, until it
blows up.
The phony money causes people to change their behavior.
They spend money they don't really have...and invest in
projects they shouldn't. Money seems delightfully easy
to come by in the boom stage and gets tossed around
casually. But what happens? Eventually, people become
aware that their investments are not producing the
profits they had hoped for. They cut back. Consumers cut
back too - realizing that they are not as rich as they
had thought. And lenders, who were happy to extend
credit to Enron and household pets when the economy was
booming, become worried. Question marks begin to appear.
Will debtors really be able to make their payments? Are
earnings really what the company says they are? Will
sales really go up in the future?
As Eric reported yesterday, lenders have become
reluctant to make new commercial loans. Is it
surprising? Bankruptcies, credit defaults, and late
payments are hitting new records. Who would want to
lend?
And yet, if the rate of borrowing and spending declines
- the boom is over.
We think the boom is over, dear reader. Because the
quality of credit has been called into question. More
and more "Enron stories" will hit the news. More and
more question marks will appear. How can the U.S. afford
such huge new government outlays? How many dollars
really are in circulation? How many more Enrons are out
there?
The boom mindset...in which everything gets better and
better for ever and ever...doesn't change quickly.
"Market metaphysics change glacially over decades," says
the Tocqueville report. Each generation learns the same
lessons, more or less. And always the hard way.
Relative to gold, we expect the dollar to fall.
Because gold production is declining. And though central
banks may favor paper currencies, the currency they most
favor is their own. While the dollar had the wind to its
back it seemed to make sense for central bankers to
lighten up on gold and hold more interest-yielding, U.S.
dollar assets. But central bankers must feel the new
chill wind too. They, too must be asking questions.
"Central banks will suspend gold sales," the Tocqueville
Report predicts, "and balk at rolling over bullion
loans. Market sentiment towards financial assets will
sour further. The bear market in financial assets,
already underway, will become more widely recognized."
The huge, long-term shifts of sentiment - from favoring
stocks and paper assets to distrusting them - will
undoubtedly continue. "How the market travels from one
extreme to the other is unknowable," continues the
Tocqueville team. "What is clear is the preponderance of
confidence or the lack of it at each extreme."
At the most recent extreme, the Bank of America lent
Bernie Ebbers millions of dollars. At the other end of
the cycle, they will feel lucky to get it back. What
will happen to Ebbers and WorldCom, we don't know. But
an ounce of gold, we predict, will still buy you a
decent toga.
Bill Bonner
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