Everybody “knows” that Gold and other precious metals go up in inflationary cycles and that US Treasury Bonds go up in deflationary recessions. Shouldn’t Gold and T-Bonds be contra-cyclical?

In this 118 page Free Investor eBook, Bob Prechter lays out the most probable scenarios for T-Bonds and Gold in today’s current and likely future economic environment. Well worth the read especially if you thought that Gold and T-Bonds could not possible go in the same direction for years on end. Prechter also reveals what he believes will be, hands down, the very best investment at the end of the depression – if it still exists.

Dec. 9 (Bloomberg) — Treasuries rose, pushing rates on the three-month bill negative for the first time, as investors gravitate toward the safety of U.S. government debt amid the worst financial crisis since the Great Depression.

The Treasury sold $27 billion of three-month bills yesterday at a discount rate of 0.005 percent, the lowest since it starting auctioning the securities in 1929. The U.S. also sold $30 billion of four-week bills today at zero percent for the first time since it began selling the debt in 2001.

What should we take from this?

One thing, certainly, is the obvious – an 80 year low in any major financial indicator is self-evident proof that something BIG is underfoot.

The Bloomberg writers attribute this historical event to institutional purchasers’ collective desire to have “something of value” on their books for their year end balance sheets. There’s probably something to that. The individuals making the decision to buy zero interest securities are employees of major institutions who have to answer to somebody about the riskiness of their portfolios.

But even if we accept that explanation as the entire story we are still left with the ugly fact that in today’s environment “something of value” means getting your money back.

The folks at Elliott Wave International are saying that this auctions is screaming “Deflation.” It’s hard to argue against that.

The TED Spread appears to be settling into the high end of the recent range. Not exactly a reason to rejoice over an anticipated credit splurge but at least something close to normal. The connection between the TED Spread and the equity markets is not 1:1. Monday’s plunge in the DOW is proof of that. You can use the TED Spread to get a handle on the willingness of big bankers to lend to each other.

Worries about a severe global economic slump should cause investors to continue to unwind riskier holdings and park funds in generally safe assets such as U.S. Treasury debt, boosting the greenback, analysts said.

Longer-dated U.S. Treasury yields fell to five-decade lows this week as extreme risk aversion fueled a frantic rush to safety. The monthly capital flows data released earlier this week showed overseas investors were big buyers of U.S. securities in September.

“The yen and the dollar will remain the only two safe-haven currencies in this global recession,” said Stephen Jen, global head of currency research at Morgan Stanley in London. “Risky assets will likely remain under pressure, as long as the end of the global recession is not in sight.”

The world’s leading economies will likely be in recession for around a year, with the UK hit particularly hard, a Reuters poll of around 250 economists across the Group of Seven nations showed this week. (Side note: On the same day that a committee of 250 economists is right about anything we will also be seeing pigs in mink coats flying down Main Street.)

Source: Reuters

A well written and insightful article that explains how the social engineering projects of the Democrats have wrecked the US credit markets. Worth the read just to know the background when you see Barney Frank mugging the camera and proclaiming himself the savior. An excerpt:

“However, the strategy announced in 1999 was to spur the banks to make more loans to people with poor credit rating, and especially to blacks and Hispanics. This was done by offering mortgages at 1 per cent above the standard variable rate. Home ownership rates among these groups had in fact been growing rapidly during the period 1993-98, 87 per cent for Hispanics and 72 per cent for blacks, but this was considered insufficient to close the gap between these and other groups. As early as 1998, Fannie Mae was already making 44 per cent of its purchases from loans to these groups.

Not everyone was convinced this was a good idea. Peter Wallison of the American Enterprise Institute warned: “If they fail, the government will have to step up and bail them out.” The US Senate finance committee in 2005 considered a bill to increase scrutiny of Fannie Mae and its accountancy mechanisms. In 2003 it had been revealed that Freddie Mac’s accounting practices contained $4.5 billion worth of errors brought about by the removal of three of the company’s top executives. By this time, combined debt at Freddie Mac and Fannie Mae was equal to 46 per cent of then national debt. The then US Federal Reserve chairman, Alan Greenspan, warned of forthcoming financial collapse if Fannie Mae’s activities were not reined in.

The bill was opposed by the Democrats, and lost.”

Source: The Australian

WASHINGTON (Reuters) – U.S. securities regulators on Tuesday gave the financial industry a reprieve from marking hard-to-value assets down to fire sale prices, throwing a lifeline to an industry beset by strained credit markets and the latest round of bank failures.

In the new guidance, first reported by Reuters, the U.S. Securities and Exchange Commission reminded financial services firms that they don’t need to use fire sale prices when evaluating their hard to price assets.

“This is a significant first step and adds stability, confidence, and liquidity within the capital markets,” said Steve Bartlett, president and chief executive of The Financial Services Roundtable. “By clarifying how to treat assets in an uncertain market, the SEC is continuing to provide transparency to investors and helping institutions to provide credit in periods of market stress.”

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Mark-to-market is a useful accounting concept when there actually is a market for the securities being valued, and a stupid bureaucratic nightmare when there is not.

There is a simple explanation for the “credit crunch.” Banks can loan at about a 10-1 ratio to assets. If a bank has $10 billion in assets it can put about $100 billion into the economy, creating $90 billion in new money or liquidity.

If the bank’s assets are suddenly devalued not only is the banks’ ability to create new money reduced or eliminated but the very existence of the bank can be placed in jeopardy. If the asset write-off is severe enough to jump the loan-to-asset ration to 15:1 or 20:1 then the bank is declared insolvent and bankrupted by the regulators.

The bank is failed and removed from the economy even though its cash flow and ability to operate are not changed by the asset devaluation. Stockholders lose everything and bank directors lose their jobs, pensions and bonuses. About 3,000 banks and savings and loans were failed in the 80s when real estate development portfolios were marked down.

Since bank directors are not of the class prone to commit personal financial suicide, whenever there is a whiff of danger to their asset valuation in the air they stop lending money to everybody and anybody.

Glad to see that the SEC and other regulators are finally getting around to scheduling a meeting to talk about the “problem.” It’s not like anybody with a finger in the bond market wouldn’t have known years ago that mortgage backed securities would be difficult if not impossible to value on a mark-to-market basis. If you ever get the chance read a prospectus on some mortgage backed derivative security and you’ll see what I mean. There couldn’t be 6 people in the entire world who could understand or explain exactly what was being sold in those offerings.

Isn’t it comforting to know that lawyers and accountants guided by the genius of people like Barney Frank will have the power to affect the US economy?

The Treasury bailout plan to recapitalize the U.S. banking system may help the U.S. avoid a deep and protracted recession. But even if the plan succeeds, it almost surely will not prevent a recession.

The major reason for this is that the credit markets have been under incredible stress for well over a year, and have recently taken a significant turn for the worse. During the last two weeks, the spread between Libor (the cost of borrowing between banks) and the rates on zero-risk Treasury bills exploded to more than 300 basis points, the widest gap since October 1987. This kind of stress reflects fear and a lack of trust among banks, which will be reflected in the real economy with a lag.

The commercial-paper market — which funds auto loans, credit cards, and short-term working capital for businesses — also is under incredible stress. Spreads on asset-backed commercial paper relative to comparable maturity Treasurys rose to more than 500 basis points in recent weeks. Not surprisingly, the commercial-paper market shrank by more than $100 billion in the last two weeks. It’s down by more than $520 billion since the summer of 2007, when the credit crisis began.

The Federal Reserve’s Senior Loan Officer’s Survey also shows record fractions of loan officers reporting tighter lending standards for the broad swath of business and household credit. Similar spikes in lending standards during 1990 and 2001 were marked by recession.

If a recession is unavoidable, the question is how deep and long it will be. While second quarter real GDP showed respectable 2.8% growth, trade was the only thing keeping the economy above water: Gross domestic purchases contracted during the second quarter. Gross domestic purchases also contracted during the fourth quarter of 2007, and only rose by 0.1% at an annual rate during the first quarter.

More bad news: Real retail sales growth has been negative on a year-to-year basis for nine consecutive months, the longest streak of declines since 1991. This data, and the tremendous spike in both jobless claims and the unemployment rate, are telltale signs of an economy that is in reverse gear.

The best we can hope for is that the downturn remains mild — and for a modest recovery to take shape in the second half of 2009. But the fiscal policies of the next administration will play a crucial role here. If tax rates on capital and labor are raised sharply, a hoped-for recovery may be jettisoned altogether.

Some have suggested we’re close to the housing price bottom. That’s hard to imagine, as new home sales just sunk to new cycle lows in August while inventories remain at elevated levels. New home sales bottomed three years before prices in the housing recovery of the early 1990s. Home prices also remain elevated relative to rents in a way they were not at the bottom of the home-price cycle in the early 1990s.

On the inflation front, the most recent bout of credit stress has a silver lining: Industrial commodity prices have declined sharply. At the same time, bond market inflation expectations recently receded to the lowest level in six years. Gold has risen aggressively off the lows of mid-September but remains below the March peak. The dollar is off the September highs, but is also well above the record lows seen in April. Collectively, these market-based signals suggest that headline inflation will ease from the 17-year highs seen in July.

The likely easing in inflation in the months ahead may not be permanent. In the past two weeks, the Fed’s balance sheet (the asset side of the monetary base) has exploded by nearly $300 billion. Yet this avalanche of liquidity has done little to relieve strains in credit markets. In other words, we cannot expect central-bank liquidity to be a substitute for financial-sector solvency.

The long-term outlook for price stability now depends on whether the Treasury pays for the bailout by selling U.S. debt to the public, or if the Fed finances it with printing-press money. If it is the latter, there will be an inflationary legacy that long outlasts the 2007-2008 credit crises.

Mr. Darda is the chief economist of MKM Partners.

Source: Wall Street Journal Opinion

“The Fed’s failure to expand the set of institutions it deals with reflects failure to adapt to the new world of financial intermediation. Previously, lending was dominated by banks, which meant the Fed could address liquidity shortages threatening the supply of credit by providing liquidity directly to banks. Today, lending is increasingly separated from banks. First, banks sell many of the loans they originate so that the ultimate lender is not a bank. Second, many originating lenders are non-bank firms. That means the credit supply is vulnerable to disruptions among these other lenders.” Preventing a Financial Crash

The columnists in the AsiaTimes are an unending source of analysis and most often criticism of the American financial system. Sometimes you can’t help get the impression that it’s a wonder our polity has managed to survive without the guidance of these ever so prescient journalists.

Hopefully, the Fed, and other Central Bankers when needed, will keep liquidity at the top of the priority list. Inflation and a battered dollar will no doubt result but those evils as bad as they can be are not fatal.

Overall, the CDX index of investment-grade debt currently trades at 107 basis points, which means it costs $107,000 to insure $10 million of debt for five years. But here’s where it gets tricky — there are various tranches of debt, some more important than others, such as “super senior” debt, which is the highest of the high, and “mezzanine,” which is the lowest of the low, the holders of which only get paid back before equity holders. That debt has experienced a huge increase in insurance costs — it now costs $569,000 for five years of insurance for $10 million, compared with $401,000 at this time a week ago, according to CDR. By contrast, the top-tier debt will cost $33,000 to insure, still more expensive than the paltry $6,000 asked a week ago, but nowhere near as severe a change. It means more investors expect default. “It seems as though every week another large government sponsored entity steps in to help the market from free falling (or correcting) and yet never quite produces lasting results,” notes Byron Douglass, analyst at CDR.

Wall Street Journal

By Susan C. Walker, Elliott Wave International
August 28, 2007
Remember that catchy love song that Frank Sinatra made popular in the 1960s, “The Best Is Yet To Come”?

“The best is yet to come and, babe, won’t that be fine?
You think you’ve seen the sun, but you ain’t seen it shine.”

At the risk of mixing musical metaphors and styles, it looks more like the sun has deserted us right now in the financial markets, and we’re about to see “The Dark Side of the Moon,” the title of Pink Floyd’s 1973 smash album. With the subprime mortgage problems reaching farther and farther out to touch hedge funds, U.S. and European banks, mortgage companies and money-market funds, what we’re going to experience sounds more like “The Worst is Yet To Come.”

That’s because the financial markets must contend not only with the credit crunch brought on by rising foreclosures now; they must also deal with the repercussions from more foreclosures over the next 18 months as more adjustable-rate mortgages (whether subprime or not) reset from low teaser rates to higher interest-rate levels.

How bad can it get? Investment adviser John Mauldin recently published a month-by-month account of the dollar amount of mortgages that will be reset through 2008, and the largest reset amounts pop up in the first six months of next year. In fact, as he points out, the $197 billion of mortgage resets so far this year is “less than we will see in two months (February and March) of next year. The first six months of next year will see more than the total for 2007, or $521 billion.”

So, we haven’t even begun to feel the pain yet. It’s bad enough for the folks who will find that they can’t keep up with the higher mortgage payments and will have to move out of their homes. But the financial markets won’t be catching a break either. The antiseptic phrase used to describe the situation is “repricing risk.” That means that investors have woken up to the fact that the AAA-rated mortgage-backed securities and derivatives they invested in look more like junk bonds now. This eye-opener causes them to want higher yields from what they now see as riskier vehicles.

That new investor caution plays out this way: investment banks, hedge funds and any other entity that bought securities backed by subprime loans now find it hard to sell the darn things. It’s almost the same as homeowners trying to find buyers for their homes – nearly impossible in a market where home prices are falling. In the financial markets, it’s nearly impossible because no one even wants to attach a price to a collateralized debt obligation today for fear that it will be priced much lower tomorrow.

The Fed can try to calm such fears all it wants by lowering the discount rate and giving banks more time to pay back loans (from overnight to 30 days), but the real problem can’t be fixed with more access to credit. The fact is nobody wants any more of that. What they really want is cash to pay off their debts, be it a mortgage or an unwinding of a securities bet.

Wall Street’s denizens are in the dark about how much their schemes depend on the ocean of liquidity created by the bull market, say Elliott Wave International’s analysts, Steve Hochberg and Pete Kendall. They are particularly struck by the image of the Grim Reaper that Business Week magazine put on its cover recently with the headline, “Death Bonds:”

“The grim reaper is the perfect visage to welcome the arriving wave of liquidation; it will wreak havoc with their work. The field’s dark fate is clear in one fund manager’s description of what caused ‘forced sales’ at another fund: ‘The models work when they look at history, but not when history is all new.’ What’s ‘new’ is that for the first time in the experience of many model makers, confidence is on the run. As they rob Peter to pay Paul, all assets will be impacted in negative ways that do not compute in their models.” (The Elliott Wave Financial Forecast, August 2007)

And the bad news just keeps accumulating:

Housing prices dropped 3.2% percent in the second quarter compared with last year, the largest drop since Standard & Poor’s started tracking home prices in 1987.
CIT Group closed its mortgage unit this week, while Lehman Brothers closed its own last week. Mortgage companies that specialize in low-quality mortgages are either going out of business (London-based HSBC) or struggling (California-based Countrywide).

The Wall Street Journal lists the number of fired employees at seven mortgage companies, including First Magnus (6,000), Capitol One’s Greenpoint (1,900), Associated Home Lenders (1,600) and Lehman (1,200), which totals more than 12,000 suddenly unemployed mortgage writers.

To top it off, Bloomberg reports that the subprime mess may lead to lower bonuses for the first time in five years on Wall Street, according to Options Group, a company that’s been tracking this kind of information for a decade.

Somewhere, the world’s smallest violin is playing a sad song for the fund managers and investment bankers who won’t be taking home that million-dollar-plus bonus this year. And Frank Sinatra is singing a sad refrain… “The worst is yet to come.”

Susan C. Walker writes for Elliott Wave International, a market forecasting and technical analysis company. She has been an associate editor with Inc. magazine, a newspaper writer and editor, an investor relations executive and a speechwriter for the Federal Reserve Bank of Atlanta. Her columns also appear regularly on FoxNews.com.

For more information on the housing market and the credit crisis, access the free report, “The Real State of Real Estate,” from Elliott Wave International.