Andrew Mickey, Q1 Publishing

Forget the current estimates, the deficits are going to be much, much worse.

Just a few days after Senator Jim Bunning was labeled a “lunatic” for trying to enforce the recently enact Pay-As-You-Go laws, the Congressional Budget Office (CBO) releasted its analysis of the Obama Administration’s federal budget proposal.

The CBO forecast the massive deficit spending to add $9.7 trillion to the U.S. government debt. That was $1.2 trillion more than the administration had forecast. The CBO expects the government debt to increase to 90% of GDP.

The thing is though, these dire estimates are extremely optimistic.

The reason is because the assumptions the projections are based on are absolutely ludicrous.

The generous assumptions include NO recession in the next 10 years (it’s the 90’s boom time all over again! What…nobody told you?), record low inflation, and businesses across the country going on an unprecedented hiring spree, just to name a few.

When these hopeful assumptions never materialize, the ramifications will be widespread. And, as you’ll see in a few moments, we believe even more strongly in our statement our complimentary gold report  issued last March:

“Every few decades though, the right conditions come along to make an absolute fortune in gold and gold stocks. Right now the conditions are right.”

Although only time will tell how bad the deficit/debt will actually be, we can be pretty sure it will be far worse than both the White House’s and the CBO’s estimates. The reason is because they are based on five assumptions which, quite frankly, just aren’t going to happen.

Unemployment Rate:

Official Assumption: 6.68% 10-year average

Reality: The current headline unemployment rate is 9.7%. The last time it reached this high was in 1982.

Back then the government was cutting taxes and deregulating businesses. They were making mostly right moves. But even making the right moves still led to an average headline unemployment rate of 7.04% for the following decade.

The booming 80s couldn’t even bring unemployment down as fast as the Obama administration expects over the next 10 years.

As long as the economy fails to ever truly recover, unemployment benefits keep getting extended, and the cost of employment (taxes, mandatory healthcare, higher minimum wage, etc.) keep going up, the next decade averaging 6.68% unemployment is nearly impossible.

Inflation

Official Assumption: 1.61% annual average

Reality: We hear all the regular talk about how inflation isn’t a problem and how the Fed – despite its entire history - will know just the right time to start hiking rates. But if you take a look at the budget assumptions, you can see they truly believe the right moves will be made at just the right time that will lead to the lowest inflation rate in 70 years.

The budget assumption is for inflation in the next decade is lower than any decade since the Great Depression. It’s lower than the 40s, 50s, 60s, and on and on. It’s lower than the long run annual average (1913 to current) of 3.4%.

It’s not impossible, but it hasn’t happened in the past 70 years and none of those decades started off with near-zero interest rates and trillions of freshly printed dollars handed over banks.

10-year T-bond Interest Rate

Assumed: 5.06% average annual rate

Reality: Despite a deficit (as a percentage of GDP) nearly tripling the GDP growth rate and a debt that’s working its way to 100% of GDP, the administration believes it will still be able to borrow money very cheaply.

The assumption, however, is more than 20% below the 57-year average 10-year treasury interest rate of 6.35%.

Unless the government will be able to borrow money at lower rates as its creditworthiness deteriorates, the government’s ability to borrow at the rate of 5.06% is highly doubtful.

Average Interest on 3-Month T-bill

Official Assumption: 3.42% 10-year average

Reality: Same situation as with the 10-year T-Bond. As borrowers credit risk increases, the cost of borrowing does NOT go down.

The assumed 3.42% rate is one of the lowest decade-long average rates in the history of the 3-Month T-Bill.

And to give you an idea of the economic conditions necessary to create such a good environment, you have to go back to the decade between 1997 and 2006. The 90-00s boom years, when population demographics and low inflation were supporting strong GDP growth and low rates, the 3-Month T-Bill yielded an average 3.42%.

Right now, none of those pillars of economic growth are present. But the budget proposal is based on the presumption they are.

Real GDP Growth

Official Assumption: 2.5% annual average

Reality: This is probably the most plausible assumption, but it’s still very optimistic. A quick look at history shows why.

During the stagflationary years between 1972 and 1982 real GDP only grew at a 2.4% annual rate. So 2.5% seems realistic. However, the boom years between 1998 and 2008 was led by 2.66% annual growth in real GDP.

Right now, the government is expecting a return to prosperity despite a massive credit contraction, increased regulation, higher taxes, etc.

Clearly, 2.5% is very optimistic.

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The budget proposal, which assumes such a strong recovery and an era of unprecedented economic growth, is presenting a “best-case” scenario. And it is still expected to increase the federal debt level by another $9.7 trillion.

It’s yet another case of great expectations. And as we say in our free e-letter, the Prosperity Dispatch, great expectations inevitably lead to great disappointments.

When it comes to the budget, the disappointment will have a widespread impact.

Just think…What happens when the best-case scenario doesn’t materialize, the coming higher tax rates reduce tax revenue, additional entitlement programs get added to the mix, or the economic consequences of a random event like a natural disaster or another major terrorist attack are added into the mix?

None of the answers are good.

For anyone interested in maintaining and growing their wealth in the years ahead, the options will be limited in this kind of environment.

When interest rates rise, the government takes resources away from the most productive areas of the economy, and consumers are paying down debt, it’s going to be a tough run for the most popular investments over the past three decades – stocks and bonds.

The markets may look good for a while longer and this rally will last just long enough for most investors to get sucked into it, but now is the time when investors look to the classic stores of wealth – gold and silver – to help insulate themselves from the consequences of the ballooning government debt which, even under the best-case scenario, are not good.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

By Andrew Mickey, Q1 Publishing

The correction in gold prices has clearly unnerved many of the newly-minted gold bugs.

The simple fact gold is not going up $20 a day has sent the “hot money” running for the exits.

Investors willing to wait out the passing storms and keep their eyes on the big prize, however, are going to do exceptionally well.

In fact, this correction is likely creating another great opportunity to reload on your favorite gold stocks.

It’s not just me who’s seeing opportunity in gold stocks now. Secretary Geithner, Chairman Bernanke, and Mr. Market have all recently signaled now is the time to buy gold stocks.

Secretary Geithner: Words that Will Live in Infamy

Over the weekend on ABC’s Sunday political show This Week, the Treasury Secretary took to the airwaves once again with plenty of focus-grouped phrases to attempt to help create the image of how worse the economy would be without the stimulus, bailouts, etc.

It didn’t take long for Geithner to get off script though. Nearly halfway through the interview he started looking ahead into the future and making some bold guarantees.

The following exchange reveals a lot of how the current administration views the massive and growing fiscal deficits and its ability to continue issuing bonds:

Jake Tapper: Is the United States going to lose its triple-A government bond rating? And what happens when the credit markets are no longer willing to buy U.S. debt?

Secretary Geithner: Absolutely not. And that will never happen to this country…

If history is any evidence, when a government representative completely rules out something from happening, it’s pretty much a sure bet it’s only a matter time until it does happen.

That’s why when a reassuring Treasury Secretary says “absolutely not” and “never,” we know the dollar’s fate is pretty much sealed.

Of course, Geithner isn’t alone. The Fed Chairman continues to see the green light to keep to the printing presses running at full speed.

Chairman Bernanke: The Only Indicator That Matters

As we’ve discussed before in Is The Free Money Party Over?, GDP growth, unemployment, and other bits of the financial news media’s “top noise” simply don’t matter too much to the Fed Chairman. The key economic indicator Bernanke is watching is consumer credit.

After all, the economic theory du jour finds deflation as the creation of all economic ills. And simply preventing deflation by any means necessary can prevent a depression will lead to prosperity and growth.

Despite how many things are wrong with that rationale, we know that means consumer credit growth is what will signal when the Fed starts hiking rates.

Right now, consumer credit is still contracting. Last week the Fed reported consumer credit for the 11^th straight month. Consumers cut their debt loads by $1.8 billion in December. That’s a sharp drop from the $21 billion in November, but since it still signals a decline in consumer spending, it’s a green light for the Fed to keep fighting deflation handing out free money.

Mr. Market: Gold Stock Timing Indicator Says “Buy”

Bernanke and Geithner are signaling good news for gold is ahead, but it’s Mr. Market who is once again signaling now is the time to get back into gold stocks specifically.

In fact, the market is saying this is the best time to buy gold stocks since the markets were still jumping off their lows last spring.

The chart below shows the how many shares of Market Vectors Gold Miners ETF (NYSE:GDX) an ounce of gold will buy over the past three years:

As you can see, the current ratio is just shy of its highs from last April. That’s a very good sign for gold stocks.

We use this ratio as the market’s perspective on the staying power of gold prices.

A low ratio (high gold stock prices relative to gold) means the gold bulls are running strong and sentiment is high. Since the market believes the future of gold is bright, they’ll bid up gold stocks much faster than the price of gold. This is a time to sell gold stocks.

A high ratio (low gold stock prices relative to gold) shows sentiment is bearish the market believes gold prices are likely to fall. Investors sell their gold stocks as they expect earnings and cash flows to decline This is a time to buy gold stocks.

Right now, with the ratio well above its short-term levels and nearly double its long-run levels, Mr. Market is telling us it’s time to buy gold stocks again.

The Long and Short of It

At this point, the short-term outlook for gold isn’t looking too bright. Since the December highs, the price of gold has fallen more than 10% from recent highs. Meanwhile, the largest gold stocks are down more than 25%.

The medium and long-term outlook, however, hasn’t changed much at all. Consumer credit is declining signaling Bernanke will keep interest rates far too low for far too long. The U.S. government seems over-confident about the tremendous appetite from a government whose debt is growing at nearly three times rate as GDP.

The combination of bearish short-term sentiment and outstanding long-term fundamentals are likely creating another opportunity in gold stocks.

We at the Prosperity Dispatch (sign up here – it’s 100% free)If you’ve been waiting for a chance to reload on your favorite gold stocks, this time is as good as it has been since last spring. Don’t let it pass you by.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

By Andrew Mickey, Q1 Publishing

They call it “burying” in Washington, D.C.

It’s when you release politically unsavory news on Friday evening. Most folks just aren’t paying attention on Fridays and by the time next week’s news cycle comes around, the mainstream media has already moved onto something new.

The ultimate “burying” days are just before holidays. This past Christmas Eve was no different.

While millions of Americans were traveling, getting together with their families, or crossing off the final names on their shopping list, the U.S. Treasury “buried” its latest addition to the unpopular bailouts for Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE).

On Christmas Eve the Treasury announced it would cover an unlimited amount of mortgage losses at Fannie and Freddie through 2012.

The real bad news, which nobody really talked about, is they’re going to need it and there are a small group of investors turning the bailout bonanza into their own gain (and you can to, more below).

This Trend is not Your Friend

The Treasury’s cap was originally set at $400 billion. Considering the Treasury has pumped $111 billion into Fannie and Freddie so far, there was still $289 left in the till.

That would seem like enough at this point, given the “recovery” and all. But it probably won’t be.

Take a look at the 10-year chart of Fannie Mae delinquency rates from Calculated Risk:

The chart, which would make even the most creative global warming climate change alarmist envious, shows there are a lot more losses ahead for Fannie and Freddie.

Almost 5% of Fannie Mae’s single family mortgages were officially delinquent at last report. The problem is the trend is still up. And it’s likely to keep going up because once all the government assistance - tax rebates, artificially depressed interest rates, and guarantees on 9 out of 10 mortgages – housing prices should be back on their natural course. And after such a tremendous bubble, the natural course would be much lower.

However, all is not lost. Government intervention always has unintended consequences. This time is no different.

The Winners and the Losers

One of the biggest reasons for removing the cap on the Fannie and Freddie loan losses was to appease the largest buyers of Fannie and Freddie bonds – China and Japan.

The government wants them to keep buying the bonds to help keep interest rates down and housing prices up. And removing the cap was a signal all would be ok for bondholders, regardless of the eventual cost to the taxpayer.

The thing is though Fannie and Freddie bonds, although backed by the U.S. Treasury, are still paying more than Treasuries. As I write, the yield on a 10-year agency bonds is 4.31%. That’s 0.61% more than the yield on the 10-year Treasury bond of 3.8%.

That may not sound like much, but a few entrepreneurial companies have found ways to exploit the difference between the yields. And they’re paying shareholders as much as 16% per year.

In a low interest rate, low economic growth environment, there aren’t many opportunities. But a 16% yield all backed by the U.S. government is a definite opportunity.

That’s why with the Treasury now fully behind Fannie and Freddie, whatever the costs, we see a genuine opportunity in the high yield stocks which are taking government meddling in stride and turning it all into hefty dividends for their shareholders.

The government may try to “bury” all sorts of news, but they’ll never get it past everyone.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

By Andrew Mickey, Q1 Publishing

The much anticipated gold correction hit faster than most expected.

After weeks of eerily consistent gains, gold is now shedding anywhere from $20 to $50 on the down days and struggling to post $10 upticks on short-lived rebounds.

On top of that, the U.S. dollar is showing its first signs of strength in months.

The new trend in gold is down. And as you might expect, the short-sighted “hot money” is finding all the reasons they can to justify selling gold.

But as you’ll see in a moment, there’s one real reason it’s still way too early to be betting against gold.

The Mainstream Goes With the Flow

All the warnings signs were there. Gold just got too hot. A healthy correction was imminent.

As of right now, gold at $1100 an ounce has done just that – corrected. It’s down 10%.

Here’s the thing though. Since gold prices have fallen, almost everyone is jumping on board to find reasons why gold is going down.

One of the “best” cases against gold came from a recent report from everyone’s favorite, nearly-nationalized lender, Citigroup (NYSE:C).

In a recent research report, Citigroup proposes, “There is no obvious relationship between the gold price and inflation.”

The firm points to the chart below as evidence:

OK, the chart does show a poor correlation between the ultimate inflation hedge and inflation. Of course, the chart conveniently starts in 1987 and the biggest divergence comes from the credit crunch, when forced selling caused all sorts of market anomolies.

Forget about inflation though. It’s only one piece of the gold puzzle.

There’s something else at work in the gold market, something most investors will miss, but is crucially important.

The “Real” Reason for Gold’s Rise

The main driver for gold prices is real interest rates.

Real interest rates are calculated by taking the nominal rate of interest (what is actually paid) and subtracting inflation.

Right now real interest rates are negative. They’re below zero. And the impact of negative real interest rates is always the same, asset bubble.

You see, when real interest rates are below zero, cash and short-term investments lose money. In this environment it’s nearly impossible to find decent yields. That’s why savings accounts, CDs, and bonds are paying next to nothing. As a result, savers and investors are forced to turn to other assets which offer return above inflation.

Historically, when real interest rates are negative, they turn to gold.

As you can see, there is a strong relationship between real interest rates and gold prices.

When real interest rates are negative, gold goes up. When real interest rates are positive, gold goes down.

The key thing is though, how long real interest rates can stay negative. Because, as long as real rates are negative, more and more investors will turn to gold.

For instance, in the 70s gold boom, gold’s ultimate high was determined not necessarily by how low real interest rates fell, but how long they stayed there. And the big gold correction in the mid-70s came when real interest rates were trending back towards positive territory.

That’s what’s going on right now. There’s a real expectation the Fed will raise rates next year which would push real rates higher.

That makes sense on paper, but only if you forget the wave of adjustable rate mortgage (ARM) resets, stubbornly high unemployment, and the most important variable the Fed is watching most closely.

Bernanke’s Hands are Tied

At this point, there’s no way the Fed can raise rates. Sure, it could take them up a quarter or a half point, but it will not do much more than that.

Over the past two years we’ve watched natural deflationary forces in action. The Fed’s response has been to slash short-term interest rates to zero and depress long-term interest rates as much as it can. Meanwhile, the official inflation rate is starting to increase and, depending on the source, the actual rate of inflation is much higher.

Basically, we’re going to be in a negative interest rate environment for the foreseeable future. And extended periods of low and/or negative real interest rates have always led to asset bubbles. Recently, low rates were key drivers of the tech bubble and the real estate bubble. Now, with little economic opportunity, more and more investors will probably find the luster of gold too enticing.

So while the mainstream focuses on inflation, they’re missing the real catalyst for gold’s recent correction to be looked back upon as exactly that – a correction and a buying opportunity.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing

By Andrew Mickey, Q1 Publishing

True contrarians should have employment on their minds.

Right now everyone is calling for unemployment to stay high for a long time. Bloomberg’s latest survey economist puts the median forecast for unemployment to stay above 10% for 2010. 

I’m sure if Irving Fisher were alive today, he’d say unemployment has “reached a permanently high plateau.”

But over the weekend, Larry Summers, the Director of the National Economic Council, made a bold prediction on unemployment. He said, “By spring employment growth will start to turn positive.”

Now, the call seems like a bold one only a contrarian could seriously consider, but in actuality it is near certain the employment numbers are about to get a lot better very quickly.

You see, 2010 is a census year and that means lots of jobs. Temporary jobs, granted, but they will reduce the unemployment rolls.

According to the Census Bureau, approximately 1.4 million people will be hired to conduct the 2010 Census. About 700,000 of them will be classified as enumerators – the people who actually do the counting.

Considering census questionnaires need to be mailed in by April and the enumerators start hitting the pavement to count the folks who didn’t mail in their questionnaire, there’s still a lot of “positive job growth” to come from the Census Bureau in the months to come.

That’s why, even if the real economy fails to create any job growth, it will appear that is has on the surface as the Census bureau ramps up its staff.

In the end, the unemployment situation will not improve until businesses get some certainty over what their costs will be (healthcare, energy, taxes, etc.).

Over the near-term, however, we expect a noticeable increase in employment (and one that’s excessively pointed to by politicians).

That’s why, in our free contrarian investing newsletter, the Prosperity Dispatch, we foresee the combination of everyone expecting the unemployment to stay and the Census Bureau’s hiring spree are clear catalysts for a surprising turn in the short-term.

Good investing,

 

Andrew Mickey
Chief Investment Strategist, Q1 Publishing