Nassim Taleb: “The Fed’s Business Is Price Instability”  A visibly agitated Taleb was in full form on Bloomberg TV with Erik Schatzker. No choice words were spared, or Black Swans strangled, during the filming of this clip.

Now that Ben Bernanke has re-introduced quantitative easing (QE2) to a mostly incredulous world and, across the ocean, the Eurozone has begun unraveling again, our thoughts should turn to the parlous state of the world and the risks ahead. These are amazing times and seem to grow more so every day. Policy errors are popping up everywhere and are likely to multiply dramatically as the political problems are serious, answers hard to find, and the decision makers are not up to the task. Bernanke has proven that he is more a college professor and less a trader, which will cost the world dearly. Sometime between June and August Bernanke lost his stomach for the “exit strategy,” probably influenced by his predecessor’s summer announcement that the US economy had ‘hit an invisible wall.” While it can be argued that QE1 has been a success due to the liquidity crisis, it did not expand the Fed’s balance sheet and came when the economy was still reeling. This new edition dramatically expands the balance sheet, actually funding the entire projected government deficit over the next few months. Although the world believes that QE2 is there to push the dollar sharply lower, Bernanke argued that his goal was something else. On the day after the Fed’s move, he wrote in a Washington Post editorial piece that QE2 would push up the equity market, bonds, and other risky securities thereby stimulating consumption and economic activity. Even Greenspan did not publicly proclaim his “put,” but now Bernanke has made it the centerpiece of US strategy. Equities are already overpriced, with profit margins at all-time highs and PE ratios far above average. Speculation is now more American than apple pie – but this is a very risky time to practice it. As one highly respected analyst noted about Bernanke’s article, “these are undoubtedly among the most ignorant remarks ever made by a central banker.” As we and many others have noted that QE has shown little or no positive impact on actual economic activity, so the Fed has taken a big gamble, and if it fails as we expect it will have nowhere else to go. With the Republican victory tainted by the Tea Party “starve the beast” mentality, austerity has come to Washington. This next year will be a terrible one for the world’s biggest economy, so we would go against Bernanke on the equity side, but buy government bonds along with him.

The Eurozone has begun its collapse a little later than we thought. My compliments to the political prowess of the euro-leaders for holding things together for so long, but this is an impossible situation and the crisis is on its way. Jean-Claude Trichet caught the spirit of the situation today in Seoul when he said that “it is absolutely necessary to change the governance of Europe” and called for moving “as far as possible in the direction of an economic and budgetary quasi-federation.” I only disagree with part of one word, ‘quasi,‘ as Europe must move to a full economic federation if the euro is to survive. With 16 countries using the euro and Estonia on the way, the odds of moving there is currently lower than infinitesimal. Things will change after the approaching horrible economic and political catastrophes that will wrack some of these economies and societies. Unfortunately nothing will happen before the current situation gets unbearable – this is the way of democratic politics. As all the leaders are still working toward the same goals, and no one has stepped forward express the inchoate fears of the European populace, this should take years. By the start of next year the Eurozone will enter a recession that will test the current leadership. The euro, which has been perceived as if it were a German mark, has already topped and will decline until it is priced like an Italian lira in the next few months. With Europe and the US in recession next year, commodity prices will drop again and global growth will suffer despite the outperformance of domestic Asian economies. With the policy stresses, and the risk of significant errors in judgment, international strife becomes more likely as well.

By John R. Taylor, Jr.
Chief Investment Officer, FX Concepts
http://www.fx-concepts.com/

Headquartered in New York City, we are one of the world’s leading independent providers of foreign currency management and research. Since 1988, we have managed currencies for institutional investors through both overlay and absolute return strategies. We employ a unique methodology integrating the study of cycles, quantitative model-building, and technical forecasting.

We have a long track record of innovation in currency management. In a market where diversification is limited, we have controlled risk and enhanced returns by using diverse instruments and markets, such as emerging currencies and options. Our track record in currency management confirms our belief that technical and quantitative models, combined with market intelligence and experience, provide consistently superior risk-adjusted performance.

Today’s Notes:

1. Rare Earths: Sanity in RUU
2. The Alberta Bakken: Primary

We’ve fielded a number of calls and emails recently on the continued rise of rare earth oxide prices and what it means for juniors in the rare earth space. It seems as if you could throw a dart at a list of rare earth names and become a winner.  The upward price momentum is relentless across the entire REE sector. A watch list of sixteen names that we track in the REE space is up 112% over the past three months. With China controlling the market and no legitimate REE production expected outside of the country anytime soon, one can see why REE juniors have had such a spectacular run.

According to Reuters, there seems to be quite a debate going on now amongst analysts and industry experts as to whether or not the rare earth space is indeed a bubble and even the New York Times has entered the fray with experts offering differing and conflicting viewpoints. 

The fact is that the entire rare earth market is small (roughly USD $1.5 billion per year today) and though it is expected to double, with an estimated 150 companies globally involved in rare earth exploration, you can expect that 150 number to decrease – likely sooner rather than later. The market just isn’t big enough to support that many companies.

We have no idea what the structure of the REE market will look like in three to five years, but prefer to keep it simple when evaluating any of these REE juniors as potential Discovery Investments. The New York Times article referenced above says that if and when Molycorp and Lynas begin production, they will account for 35% of China’s current supply. The devil is always in the details, however, and this is a big “if” and “when.” In addition, of course, each rare earth deposit is unique in many respects. It’s the heavy rare earths elements that are much sought after. Finally, the rare earth space is really about an entire supply chain not just a mine.  Since about 1990 the IP for such a supply chain has migrated to China. It will take time to restore it.

The Ten Point Grid for Discovery stocks is a tried and true measure of potential wealth creation and can help in keeping the investment evaluation process clear and simple. However, taking it one step further, we’ve focused on several criteria specific to REEs:

• The composition of any REE deposit – is it predominantly heavy REEs (HREEs)? The one thing people involved in the REE industry can agree on is that HREEs are more valuable than the light REEs (LREEs).

• Has the company solved the metallurgy? This is key. As REEs occur together naturally and each deposit is unique, the ability to successfully (economically and environmentally) separate the 17 REEs from each other is an absolute necessity. The Chinese have proven they can do this, but they did it at a huge cost in degradation of the environment. Who else outside of China can make the same claim?

…..read pages 2-5 HERE

A couple of weeks ago, we brought you Part I of an interview Eric Fry conducted with Dr. Marc Faber from the sidelines of our annual investment symposium in Vancouver, Canada. They chatted about all the usual stuff: deflation vs. inflation, the emergence of developing economies and the ever-changing landscape of today’s investment environment.

In Part II of this interview, which we present below, Dr. Faber highlights some attractive, often overlooked markets in which readers may consider investing some of their money and/or time. Plus, there’s some bonus advice for any blind and/or asexual readers who might be tuning in. Watch the video below or read the interview HERE.

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