In October of 2007, Bob Hoye of Institutional Advisors was on Money Talks when he made it very clear, crystal clear to get out of the markets. He said a credit tsunami was about to absolutely overwhelm us.. Obviously a very, very valuable call. He also declared publicly to get back into the market at the end of the 1st quarter of ’09. That’s why I’m really pleased to get his perspective.
Michael Campbell: Bob, we just heard Bernanke give his semiannual update in the US. What do you think is happening out there?
Bob Hoye: A big financial mania is beyond the control of any government or any government agency. It’s a crowd phenomenon thing, and there is nothing he or they can do about it. The irony is that when the mania is on, you have the guys on the Policy side say, “Hey, this is all due to our brilliant, policy manipulations. We just know how to change interest rates, we can manage this boom and we’ll run it forever.”
Michael: Do you think that the government officials generally understand that they can’t do anything really?
Bob: No. When a boom is on they really, I’ve got this going way back to 1825, they really believe that it is due to their brilliant management and it will continue. Then it fails as the momentum of equities or real estate that’s being speculated in just stops going up. Thats when the power shifts from central banker whose new job is to keep the bubble going and get the accounts offside over to the margin clerk whose job is to get the accounts on side.
Michael: So the Government solution to the debt problem is to encourage people to take on more debt?
Bob: Well the first person in writing that proposed that idea of growing credit and the credit contraction would go away was a guy by the name of Edward Misledon in the crash of 1622. Every other generation seems to bring forward an intellectual who comes up with that brilliant idea. The problem is that the whole system in a speculative fury, takes on more debt than can be serviced in an ordinary economy. But the problem is, because of crushing equity and asset prices you get the drop in the economy and you just can’t service the debt. That’s the problem. When Amsterdam was the World’s leading financial capital they had a term for credit when it was available, they called it Easy Money. To this day the guys in Bond Trade still say it’s Easy Money.
Michael: How can policy makers influence consumer psychology?
Bob: They can’t. In the early 1930’s Banks stopped lending money to individuals and corporations because they were empty. Banks that did have some money bought treasury market. I believe that is going on now as well. Then the intellectuals get upset about hoarding of cash. In the 1930’ retail stores even had anti-hoarding stickers in the window. The behavior of policy makers through every bubble has been the same. At the top say it’s managed. Good policy. In the crash they turn around and look for scapegoats to lay the blame on. Then you go to a period of regulation increase in order to close the barn door after the horse is gone. And then the next flight comes in, one you have a great financial bubble turn into a great depression.
Business contraction starts virtually with the bear market. So the top of the stock market was in late October 2007, then the NBE came along and said that the Recession started a month later. Now as you and I know through our experience in the market, you have a stock market high and then later on, a year later you have the high for the economy. That is usual. The only time you get the failure of the business cycle with the stock market is at the end of the bubble. So where I sit on this one is that when the panic down ended in March a year ago, the rebound would have a rebound in Business activity. Then when eventually the stock market peaked in April 2010, the stock market would go down and it would re-take the economy with it. May 2010 started the resumption of bad economic news and last week’s Housing number was a disaster. So this is working that you have a rebound in the stock market, you get a rebound in business activity. Then both fail at the same time. In my mind we are in a severe post bubble contraction and it will go on for some time.
Michael: Are you on the deflation side too?
Bob: Yes, we should look at a boom as a credit expansion, a credit inflation. Then you, as the prices fall credit becomes unserviceable and then it contracts. It keeps contracting. So it’s a credit inflation followed by a credit deflation, prices go up, prices go down. And this is going to go on relentlessly. One of the blunders in current thinking on economics is that they look back, and this is ironical because Bernanke is one of the leading scholars on the post 1929 contraction, and they all conclude that the Fed was tight. It wasn’t. There was evidence in the newspapers that in the summer of ’29 when the Fed raised the cost of money to Wall Street at the same time they were easing money to Main Street. Then in the crash the head of the New York Fed, which was giant compared to all the other chapters, opened the discount window and bought bonds out of the market. Exceeded its lending authority by a factor of six times. In January, February of 1930 the fed in a bulletin said that they met the panic in the classic way by liberally discounting, which they did. Then you go to July 1932 which was the bottom of the market and Barrons’ had an editorial that said, ‘Every anti-deflationary measure taken by the Fed is not working.’ The problem was that the vortex of deflation kept sucking bond prices down.
Michael: How I should be approaching equity markets right now?
Bob: Well as I said there was a very good top for the US stock markets in April and May. Through the summer it’s just been a sort of a choppy market favoring slightly the down side but then we typically get a nice rally going into the turn from August to September and it’s happening. We had a good day Friday and this is likely to continue into next week but this is just the seasonal sort of little lift in the markets that will be followed by further decline.
You have the spreads for junk bonds out almost to as wide as they were in the June hit. The long end spreads have been widening since May and that’s a bad sign. The weakness in base metal prices is not good. In Money market maturities of less than one year maturity rates continue to decline and the Ted spread it continues to narrow. A lot of thinking people are packing money in at the short end. Its not because it is fed policy to have low interest rates, its that we’re in nervous times and careful money is parking in the most liquid item which is treasury bills in the US.
The other most liquid item of course is gold. There is a constant accumulation of Gold going on. Technically the nominal price of Gold, the real price as we calculate it relative to commodities is going up. This is a good thing for gold mining for improving profits margins but it’s a bad thing for the stock market. Another indicator we find reliable is the gold silver ratio. It has a tendency when it turns up to signal a wave of credit concerns. The gold silver ratio is now about 65, if it goes right through 68 we’ll say watch out, we’ve got a liquidity problem coming.
Michael: The spread between what the Greek government pays for 10 years money in Euros and what the German government pays is now 9%. Is that a look out?
Bob: It is indeed. I’m positive next week the bond market is going to be heading south. On the ten year note this week we got upside exhaustion readings, which means the best is in. The dynamics are there for an important top in bond prices and they are about to head down. Another sign that there is a problem.
Michael: If bond prices head down, will it not provide an opportunity to get higher yields?
Bob: Eventually yes, but the point is that the bond market in the last few months has been the only game in town and there’s been a lot of speculation. Still, there’s no shortage of supply of bonds from that crazy White house administration. I think this is the move where the bond vigilantes come in and say “No Mr. Treasury you’re not going to flog any more of these bonds to the market.” I’m looking for a real serious convulsion in the bond market.
Michael: The US Dollar?
Bob: All of this debt that was expanded during the bubble, let’s say the majority of it, is due payable into New York in US dollars so that represents a huge short position of US dollars. If we go back into history, the records shows after the financial mania blew out eventually the senior currency becomes chronically strong relative to most commodities and other currencies. It used to be Sterling it’s now US Dollars. It’s very simple, those who borrowed US Dollars because they thought US Dollars were going to go to zero now owe them due and payable due in New York. It’s a huge short position and the Dollar’s going to go up and up and up. It’s fascinating.
Michael: Bob, to summarize there is an opportunity to be short the Government bond market which has run to exhaustion. If your not inclined to short you’d be cautious, raise cash, and you don’t mind having your long term gold position. Have I missed anything?
Bob: One trade you can is the gold-Silver ratio. If it breaks through 68, it might run to 75. In the crash in ’08 it got out to 84. Also while you can sell some of your gold stocks, we’re always interested in the junior exploration stocks. You can’t move around too quickly so you can hedge yourself with the new junior-gold-stock ETF symbol GDSJ in the states. One of the other ways would be to most certainly sell your silver stocks and also play the short side on silver stocks. It will make you some money and protect your core positions and gold.
Michael: Great Bob, as usual a real pleasure to talk to you. I hope we can visit again in the very near future, I always find it fascinating.
Bob: Mike, I enjoyed it.
Bob Hoye www.intitutionaladvisers.com.