1st august 2009

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report

1st August 2009

Raiders of the false dawn

A calm interlude - buying LVMH

My analogy has been that our central bankers and politicians in

the UK and US are taking us on the economic equivalent of Captain

Willards journey up the Nung River in the movie, Apocalypse

Now. If you indulge me in this analogy, the question is where are

we now? In the lm, the gun boat emerges from swirling mist

(how apt) and Willard (Martin Sheen), sitting on the bow, sees

some buildings up ahead. This is the famous French Plantation

scene and is the lms calmer interlude. It was cut from the

original movie release, but reinstated in Francis Ford Coppolas

Redux version (thanks for this DVD to David V. in NYC).

Assignats - led to the French hyperination of the 1790s

Source: usagold.com

During dinner, the French patriarch, De Marais (played by Christian

Marquand) discusses the French defeats in World War II, in Nigeria

and, in particular, at Diem Bien Phu, which led to the withdrawal

from Indochina, the separation of Viet Nam into the North and

South and, subsequently, the disastrous US intervention. There is

a poignant moment where one of the diners asks Willard why theUS cant learn from French mistakes? (the lesson of the excessive

issuance of assignats leading to the French hyperination of the

1790s also came to mind!). The next morning, Willard is back on

Contact/additions to distribution:

Paul [email protected]

This issue:

A calm interlude - buyingLVMH

China - learning the art of

bubble economics (here)

Cycles - a new pretender toMartin Armstrong (here)

US house prices - recoveryikely short-lived (here)

Gold - more insight on whatsreally going on (here)
mailto:[email protected]:[email protected]

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2/142 Thunder Road Report - 1 August 2009

the boat and the mist is even thicker. So much so, that Chief wants to stop because he cant see where

hes going. Willard pulls rank and on they go.

In the last Thunder Road, I argued that the heavy-handed intervention of politicians and central bankers

was pushing us into a distorted Kondratieff Winter. What I meant was that in the normal course of

events, we would experience a deationary depression for 10-15 years while debt and excess capacity were

purged. However, the intervention, i.e. offsetting inationary policies, are so extreme that the evolution of

events will be far more complex this time, with more twists and turns along the way. Making money is very

difcult at the moment and even the Trader Wizard, Bill Cara, is nding the going so tough he is heavily

in cash and watching from the sidelines:

the risks are just too great. When you see a cash ow stable Microsoft drop -10% in a day or a McDonalds

-5%, how can anybody commit 100% of their capital to such a market environment. I know I cannot.

I have to invest more aggressively and Ive put some of the cash I had on the sidelines back into the market

both a bit before and after the Dow Theory. buy signal which was triggered on 23 July 2009 when both

the Dow Jones and Dow Jones Transportation Index broke through their previous peaks (on the 12 and 11

June 2009, respectively) in the current rally. Thats not because I trust this rally, rather I cant afford to be

left out of a rising market to any signicant degree. As well as adding to my heavily overweight positions

in gold/silver and technology stocks, I bought shares in luxury goods group, LVMH (albeit with a 6% stop

loss), after it announced its rst half 2009 results last week.

Why a trade in luxury goods? It struck me that a combination of the recent return of the bonus culture

to parts of the nancial sector, the possibility of a bubble developing in China (discussed further below)

and the likely response of the ultra-rich to the recent stock market rally all bode well for this sector in the

current quarter. At the same time, Japan, which is the biggest market for luxury goods (> 20% of the world

market), should benet from recovery in China, its largest export market. Japanese department store sales

have seen double-digit declines in every month bar one since last December and surely some improvement

is due?

LVMH.is the worlds largest luxury goods play with major brands such as Louis Vuitton, Moet & Chandon,

Hennessy (cognac), Christian Dior, Marc Jacobs, Fendi, Donna Karan, Givenchy, Tag Hauer, etc.The H109

results were marginally worse than expected due to margin weakness in Wines & Spirits and Watches &

Jewelry it looked to me like analysts underestimated the operational gearing in these divisions.

Despite the worst recession since the Great Depression, organic sales only declined by 7% as the group

saw market share gains across most of its brands, especially Louis Vuitton. Fashion & Leather Goods, which

accounted for 64% of group operating prot, reported organic sales growth in local currencies of 1% overall

with 18% growth in Asia a remarkable performance in my opinion.

By the way, according to Vogue UKs August 2009 issue:

The fashion gods have spoken: this autumn, its all about the shoulder.

I read it.

black dominates, along with urban gray. However, indigo tones from smoky teal to luscious purple are

the shades that mesmerise.

In the second half of 2009, LVMHs management is expecting more market share gains due to numerous

product launches and further expansion in emerging markets. LVMH has one of the largest exposures

to emerging markets in the luxury goods sector 32% of sales are outside the US, Europe and Japan,

including 24% in Asia ex-Japan. Hennessy is the biggest selling cognac in China. At the same time, LVMHis aggressively cutting costs down Euro163m in H109, equivalent to 10.6% of H108 operating prot from

recurring operations. It would be even better if they could do more on inventory management. In PE terms,

on c. 17x 2009E and 15x 2010E, the stock is only trading in line with the sector average, excluding the very

highly rated Hermes.

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On the subject of luxury goods, my interest was also piqued by a small piece in Saturdays Daily Telegraph

noting that:

The price of Chateaux Late and Latour, the two most celebrated claret houses, is surging as new investors

develop a taste for ne wine. Wine is in for a bumper year say dealers, thanks mostly to Chinese buyers.

In relation to wealthy Chinese buyers, Simon Berry of wine merchants, Berry Bros & Rudd, is quoted as

saying:

They really like the big names Late and Latour.

LVMH has its fair shares of big names in its stable of luxury brands.

China learning the art of bubble economics

While I remain bearish on the prospects for the US and UK economies, the key question on everybodys mind

is whether China is heading into a bubble. It certainly looks like it to me notwithstanding some restraint

by the authorities being inevitable. The economic recovery in China is purely a monetary phenomenon

driven by the governments stimulus package and aggressive bank lending. While we all know that there

are caveats regarding Chinese data, the reported Q209 GDP growth gure was 7.9% and 7.1% for the rst

half of the year as a whole. Growth must be picking up strongly because Chinas power generation rose

5.2% year-on-year in June 2009 after declining by 1.7% during the rst six months of this year.

The worrying aspect was the make-up of the H109 GDP growth. Of the 7.1% growth, 6.2% was driven by

investment, 3.8% was consumption and net exports contributed minus 2.9%. At this point, with plenty

of spare capacity already, it might be preferable to have the numbers for investment and consumption

reversed. Whats more, the amount of newly started xed asset investment projects doubled in H109,

implying a lot more investment is already baked-in.

Two other data points have prompted much discussion:

B Chinese bank lending went ballistic in June 2009 with 1.53 trn yuan (US$224bn) which was double the

May gure. This led to the highest rate of money supply growth in 14 years with M2 growing 28.5%

year-on-year; and

B Chinas foreign exchange reserves increased by US$177.9bn in Q209 to US$2,132bn. This was a massive

increase from the previous quarters US$7.7bn and is far bigger than the aggregate of the countrys

trade surplus and foreign direct investment implying hot money owing in from overseas. As Doug

Noland of the Credit Bubble Bulletin pointed out:

the most recent quarter exceeded even the US$154bn increase near the height of the hot money bubble

period back in early 2007.

While they set the alarm bells ringing, an email sent to Michael Pettis of the China Financial Markets (and a

professor in Beijing) blog from a fund manager is a must-read. The fund manager had just returned from

looking at real estate in Guiyang, the major city in the Guizhou province in Southern China. While this

relates to one major city, it is hard to believe there arent other examples but here it is:

I thought Id seen insane excess in the past 200 thousand square meter malls completely empty next

to apartment complexes with 40 thousand units and 30% occupancy rates, etc. etc. But what we saw over

there is rather hard to fathom. It seems the Guiyang city mayor had the same idea as the Shenzhen mayor

to move the old downtown to a piece of undeveloped land.

Of course Guiyang has a quarter the population and probably a quarter the per capita income of

Shenzhen. They built sprawling new government buildings about a 20-minute drive north of town. And

then the residential high rise projects started going up. From driving around the area, we gured well over

100 20+ storey buildings.

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What was most distressing was that the development has been totally uncoordinated a project with 15

buildings here, in another eld two miles away a project with one building, another mile in another direction

three buildings, sprawled over what was easily over 30 square kms of farmland well north of town. Every

building we got close enough to see was either incomplete/under construction, or empty. Our tone gradually

went from Haha, another one! to Oh my God, another one. We conservatively guesstimated that we saw

US$10bn of NPLs (non-performing loans, Paul) in one afternoon. The only buildings that were occupied

were six-storey towers built to accommodate the peasants who had been displaced by the construction.

Back in the city proper, every neighborhood we saw was a convulsing mess of buildings being torn down,

new ones being built, and unnished high rises starting to crumble.

The Chinese central bank has tried to soothe concerns with the Assistant Governor, Li Dongrog saying two

weeks ago:

we will strengthen monetary and credit management to ensure stability in the nancial sector.

The overwhelming expectation of analysts is that the Chinese government will act to rein in excessive

lending but, as Pettis says, there is division of views:

Although I am often surprised by how eagerly foreign commentators have embraced the Chinese scal

stimulus story and see it as a great, shining success, I am happy to say, mercifully, that in China there is a

lot more skepticism. There seems to be a serious debate among Chinese policymakers over the stimulus

package. The debate lists, on one side, people centered on the PBoC, the CBRC and the National Bureau of

Statistics, who are worried that the stimulus may be exacerbating Chinese imbalances. On the other side

are people in the State Council, the Ministry of Commerce and in the provincial and municipal leadership

who are more worried that any half-heartedness will lead to a signicant rise in unemployment.

Im sure there will be some policy tightening, but I think it will be taken in baby steps in true Greenspanian

fashion. As mentioned above, the governor of the Peoples Bank acknowledged the very uncertain outlook

and the authorities will be very wary of further social unrest. Here is an interesting report from Platts on27 July 2009:

Jianlong Group has been told to abandon takeover plans for Chinas state-owned Tonghua Iron & Steel

Group after a company executive was beaten to death Friday as 3,000 steel plant workers protested job

cuts, a provincial government ofcial told local media Monday. Jilin provinces Development and Reform

Committee has ordered Jianlong to halt its restructuring plans and told mill workers to return to work, the

ofcial said.

Jianlong ofcial Chen Guojun was killed when a brawl broke out after Tonghua workers were told to expect

job losses during a meeting with a delegation from Jianlong, a private company based in Beijing. It was

the second time Jianlong had launched a takeover bid for the state giant and many feared the companyplanned to drain state assets before following up with cost-cutting measures, including redundancies, in

northeast Chinas old industrial heartland.

That shows just how desperately China needs either to increase domestic consumption (good for luxury

goods!) or has to hope for an improvement in export markets like the US but reduced imports were a

benet helping the US to report better-than-expected Q209 GDP of -1.0% last week (the main reason

being government spending in Obamas USSA).

Down the road, it is highly likely that we will have to worry about bubble economics in China and knock-

on implications for the global economy, but not for now. Unlike the US and UK, China has the reserves to

pursue a very aggressive stimulus-driven recovery without bankrupting itself for a lengthy period.

There are also some possible early warning signs that bubbles could emerge in other nations. For example:

B Bank lending in Brazil rose 19.7% in June versus the previous year. The gure of US$679bn was a

record; and

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B New mortgage loans approved in Hong Kong in June rose 36.5% from May to a record HK$38.4 billion

($5 billion) in June;

Cycles a new pretender to Martin Armstrong

Despite all the talk of rising stock markets, stabilising real estate prices and Chinese bubbles, we shouldnt

forget that the central bankers and politicians are ghting a desperate battle against the downward

gravitational pull of massive debt-deleveraging across the developed world. This was only too apparent

in the US Q209 GDP gure from last Friday where consumption (70% of GDP) fell 1.2% which was twice

the expected decline.

More original work suggesting that we are far from the end of the current down cycle has been written by

Stephen J. Puetz in his new book, The Unied Cycle Theory.

Stephen Puetzs new book

Source: Amazon

Ive said before that Martin Armstrongs Its Just Time the decline and fall of the United States? The

global nancial system? Or capitalism? is probably the nest piece of nancial analysis that Ive ever

read. Armstrongs Economic Condence Model and his other cycles predicted the 1987 crash, the onset

of Japanese deation in 1989 and the onset of the current crisis as well as many other key nancial and

economic events. I hadnt heard of Stephen Puetz but recommend his book which Im part of the way

through.

While Armstrong has his core 8.6 year Economic Condence Model, Puetz has a 6.36 year economic

uctuation/recession cycle. While they might seem very different at rst sight, there is some similarity at

their core. Before looking into them in more detail, its worth just noting when each of them predicted the

peak in the current economic cycle:

B Armstrongs 8.6 year cycle peaked on 27 February 2007; and

B Puetzs 6.36 year cycle peaked on 24 January 2007.

So they predicted a peak in the cycle within a month of each other. The emergence of the sub-prime crisis

arguably surfaced with the announcement by HSBC on 7 February 2007, i.e. slap bang between the two, of

an earnings shortfall in its US subsidiary due to rising delinquency trends in sub-prime mortgages.

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Looking at Armstrong and Puetzs cycles in a little more detail:

B Armstrongs 8.6 year cycle is composed of 4 x 2.15 year cycles, Puetzs 6.36 year cycle is composed of

3 x 2.12 year cycles, i.e. they identify a shorter term building block cycle, if you like (my term), which

is only 1.4% different in both cases.

B Armstrongs 8.6 year cycles build up in groups of six into a 51.6 year cycle. Puetzs cycles always build

up in units of three so three units of 6.36 years build into a 19.08 year cycle of nancial panics andbear markets. In turn, the 19.08 year cycles build up into a 57.24 year cycle of economic depression.

B Both Armstrong and Puetz acknowledge that their cycles of 51.6 years and 57.24 years, respectively, are

similar to the 50-60 year cycles identied by Kondratieff.

I nd it very interesting that both Armstrong and Puetz identify almost identical cycles of just over two

years, i.e. 2.15 and 2.12, respectively. It was the discovery of this cycle which provided the foundation for

his work as Puetz explains:

The basis for this research started with my discovery of a 2.1 year cycle that dominated stock market

activity over the past thirty years. I wondered if this cycle could be connected to various cycles already

discovered by others. The core of the Unied Cycle Theory arose from three ideas. First, the concept that all

waves appear as components of larger waves came from the Elliott Wave Theory. Second, Edward Deweys

(who set up the Foundation for the Study of Cycles, Paul) observation that cycles often appear in harmonics

of three was employed. Third, the theory used cycles already identied by the Foundation for the Study of

Cycles.

Im still only part of the way through Puetzs book so I havent got an in depth understanding of his whole

thesis yet. However, he also identies interesting longer term cycles such as a 171.72 year cycle of severe

economic depressions. The resulting weakness he argues subjects nations to both external attack and

massive civil discontent. The current 172-year cycle also peaked on 24 January 2007 which hardly bodes

well. Last time it peaked in 1835 marked the collapse in railroad stocks, the longest bear market in UShistory and was followed in 1861-65 by the American Civil War.

Turning to Martin Armstrong, I should mention that his cycle work is multi-dimensional and goes well

beyond the 8.6 year core Economic Condence Model and its related harmonics, e.g. 51.6 years, etc. For

example:

B There is a six year intensity cycle which runs parallel to the 8.6 year cycle and can cause giant or

rogue waves when the two interact.

B A 37.33 year monetary crisis cycle which peaked in 2008 spot on given what happened with Bear

Stearns, Lehman et al and usually leads to fundamental changes in the monetary system itself (when

gold has typically performed very well as Ive argued previously); and

B There is a 224 year cycle of political change which, taking the American Revolutionary War in 1775 as

the starting point, peaked in 1999 (was this the peak of the US as a super power?);

But cutting to the chase, what does Armstrong and Puetzs cycles work say about the outlook? They are

both bearish, a view which Im in agreement with:

B As highlighted in a previous Thunder Road, the current downturn predicted by Armstrongs 8.6 year core

cycle does not reach bottom until June 2011. Additionally, the next peak in the six year intensity cycle

is 2011, so 2011 could be a very dark ride! And we have to get there rst.

B Puetzs 6.36 years, 19.08 years, 57.24 years and 172 year cycles all peaked in January 2007. As he

says:

The Unied Cycle Theory projects massive deation for decades to come...more than likely, an economic

depression started during July 2008 (with the break in commodity markets). And will probably exceed the

Great Depression in severity.

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As Ive said before, Bernanke, Geithner, King, Darling et al are trying to defy economic gravity. Whilst

hoping otherwise, Im not optimistic that they offset the downward gravitational pull without destroying

their respective currencies. Puetz gets this:

once a civilisation passes its prime, monetary authorities debase their coinage to sustain their spending

programs. In modern times, central bank credit creation equates to the coinage debasement practiced by

ancient, declining civilisations. In both cases, monetary systems disintegrate in ways that provided short-term benets at the cost of long-term stability.

Puetz acknowledges that his cycles work doesnt always predict stock market and economic events

precisely, but hes usually fairly close from what Ive read so far. Puetzs work predicted a stock market

high in December 1987 so two months after the timing of the crash. Where his work seems to have been

weakest is in regard to the Great Crash of 1929. While Armstrong nailed it almost precisely if you project

his model backwards, Puetzs 6.36 year and 19.08 year cycles peaked in September 1930, ten months

after the Crash. His 57.24 year depression cycle peaked in 1949 and I havent yet got my mind round his

explanation for the deviation yet.

There is fascinating stuff in Puetzs book on how geomagnetic changes inuence behaviour and nancial

markets. I noted in a previous Thunder Road how several nancial panics have corresponded with peaks in

sunspot activity. Heres an interesting quote from page 64:

on the rst full moon after a solar eclipse, a panic-phase begins. A panic phase usually lasts two weeks

ending at the time of the next new moon.

As you probably remember from the TV news, we had a solar eclipse on 22 July 2009 with the best views

being from South East Asia. Checking the full moon dates for 2009, the next one is due on 6 August 2009.

Out of curiosity, I checked whether there was a solar eclipse last year and there was one on 1 August 2008,

followed by a full moon on 16 August - so there should have been a panic-phase lasting through to the

end of August. Lehman Brothers went into collapse on 9 September 2008 when the Korea Development

Bank declined to invest in the bank. Still, thats not too bad as a predictive tool. Lets see what happens in

the coming weeks.

US house prices recovery likely short-lived

The US housing market was the catalyst for the current crisis and, after 33 consecutive monthly declines,

the latest Case-Shiller data published on 28July 2009 for May showed that the 20-City Index rose by 0.5%

on April. This wasnt particularly surprising after the decline in the previous month was almost negligible at

0.6%. What amazed me was that the cheerleading anchors on CNBC didnt make more of it. Maybe they

were told to be downbeat on the stock market last week when the US Treasury had a record amount of

bonds to sell?Is a sustained recovery in US housing in prospect? Larry Edelson of the Real Wealth Report, who has made

some good calls in the past, believes so. He recently made a high conviction bullish call US House Prices

Have Bottomed (here) stating that it is:

a forecast that I want to put on the record.

He went on:

I believe U.S. real estate prices have bottomed and are on the mend. Not many will agree with me. Thats

for sure. And mind you, my forecast doesnt mean property prices in every town in the United States

have hit bottom. Nor does it mean you should run out to blindly buy property and expect to get rich on it

overnight. But all the evidence I see tells me real estate prices in the U.S. are now a bargain that were at

the bottom and that there will be a recovery in property prices, albeit slowly, over the next several years.

The main reasons for Edelsons optimism are:
http://www.uncommonwisdomdaily.com/us-real-estate-prices-have-bottomed/http://www.uncommonwisdomdaily.com/us-real-estate-prices-have-bottomed/

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B Inventories of existing homes are down to a level which Edelson believes will see house prices nd

support;

B The Pending Home Sales Index (i.e. sales that will complete within two months) has risen for ve months

in a row;

B Housing affordability has improved with the trend in house prices dropping all the way back to that of

the reported CPI.

Other factors put forward by Edelson are that new home inventories are below their average level of the

last forty years and house prices for overseas purchasers are at their lowest level for a decade helped by

the decline in the dollar.

Edelson is so bullish that he nishes with what he calls a little unconventional wisdom:

Dont expect any rise in mortgage rates to kill off a recovery in U.S. property prices.

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Quite to the contrary, I would consider rising long-term interest rates bullish for U.S. property prices. Chief

reason: Rising interest rates will likely set off a stampede of potential buyers and investors to get into real

estate before rates head higher.

I have my doubts about that, but lets consider the bearish case put forward by Whitney Tilson and Glenn

Tongue of T2 Partners in their latest presentation (here) from earlier this month. T2 believe that the current

signs of stabilization are the mother of all head fakes. Firstly the fundamentals remain negative:

B While Edelson talks about the fall in inventories providing support for house prices, the T2 guys argue

that at 10.2 months of supply, the industry is still close to a peak. Not only that, but even this gure fails

to take account of the signicant shadow inventory homes that banks have foreclosed but not listed

for sale and homeowners who cant sell because they are so underwater;

B The trend in foreclosures remains upwards, While the May data showed a 6% decline to 321,480, it

was still the third highest number of foreclosures behind those of March and April. Last Wednesday,

RealtyTrac published the data for June and the rst half of 2009. June foreclosures rebounded back to

336,173 while total foreclosures for the rst half of 2009 were 9% above the previous six months and

15% higher than a year ago. According to James J. Saccacio, chief executive ofcer of RealtyTrac:

In spite of the industry-wide moratorium earlier this year, along with local, state and national legislative

action and increased levels of loan modication activity, foreclosure activity continues to increase to record

levels,

Looking through the presentation, there are other reasons why the foreclosure rate is likely to continue

increasing

B There is a staggering statistic on Option ARMs which I hadnt appreciated about 80% of them are

negatively amortising, i.e. unpaid interest is being added to the value of the loan. Most Option ARMs

reset to fully amortising after 5 years unless negative amortisation reaches 110-125% of the original

loan in which case it is automatically triggered. Outstanding Option ARMs amount to about US$750bn.B the resets of Alt-A mortgages have hardly even started there are nearly US$200bn during 2010-12.

They also have some worrying charts showing the rapidly rising delinquency rates for jumbo prime

mortgages and HELOCs (Home Equity Lines of Credit) as well as Alt-As. Outstanding HELOCs amount

to about US$1.1trn.

On the subject of the problems spreading to higher quality borrowers, Lender Processing Services noted in

a report from last Wednesday:

Reecting the mortgage crisis evolution away from all things subprime, prime jumbo mortgages continue

to fare the worst, comparatively: foreclosures among good-credit borrowers with high loan balances are up

a whopping 580% since Jan. 2008

The conclusion of T2s analysis is that US house prices will almost certainly fall by a further 5-10% down to

the long-term trend line at 40% below the peak. The bigger question for Tilson and Tongue is whether they

overshoot on the downside? Their view is that this scenario is highly likely due to overhanging inventory,

negative psychology (buyers continuing to hold back) and further weakness in the economy. They do not

see a bottom until mid-2010.

On the subject of overshooting on the downside, Andrew Butter (managing partner of ABMC in Dubai) wrote

a interesting piece on house price valuations (here) in the US and UK. Butter has a quantitative method for

valuing house prices (based on income capitalisation and long-term interest rates) and then showing the

divergence from the theoretical equilibrium. Unlike UK house prices, his analysis suggests that US housesprices dont always correct to below their equilibrium level, although that is the normal course of events:
http://www.moremortgagemeltdown.com/download/T2_Partners_presentation_on_the_mortgage_crisis_.pdfhttp://www.marketoracle.co.uk/Article6250.htmlhttp://www.marketoracle.co.uk/Article6250.htmlhttp://www.moremortgagemeltdown.com/download/T2_Partners_presentation_on_the_mortgage_crisis_.pdf

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US and UK house price - over/under-valuation (1945-present)

Source: Andrew Butter

After the biggest rise during the entire period, I would be surprised if the quid pro quo was not a period of

below equilibrium pricing.

Gold more insight on whats really going on

In the last two Thunder Roads, I argued how we are getting close to a dollar crisis and the disappointing

US Treasury bond auctions last week were an early sign of its approach. On Wednesday, the bid-to-cover

ratio of US$39bn was a worse-than-expected 1.92. Of course, this is very positive news for real money,

like gold and silver, but with a total of US$115bn of Treasuries to sell this week and its Chinese creditors

in Washington DC, the gold cartel went into action gold went down while the dollar had a sudden (and

probably brief) reversal just as it was set to test its June low. When the Treasuries had been sold and the

Chinese left town, up went gold and down came the dollar.

Gold price (US$/oz): 29-31 July 2009

Source: Kitco

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Obama, Bernanke and Geithner continue to play lip service to bringing down the US federal decit but their

actions and future plans only make the situation even worse.

In the wings, despite the denials, it looks like a new stimulus programme is being prepared by the US

government. There was an interesting nugget of information from San Diego-based fund manager, Jim

Puplava, the weekend before last:

We may get one to two, maybe possibly three, quarters of positive economic growth but you are going tosee the unemployment rate climb close to 11%. The economic growth rate, even if we see it turn positive,

will be so low it will be anaemic. And then were going to go right back down again which is why they are

secretly working on a stimulus bill and I want to tell you folks, were going to get another oneI have it

on good authority from the services we subscribe (sic), one of the economists is working with Pelosi on a

second stimulus package that may be proposed in the Presidents State of the Union speech in January.

Then theres the proposed healthcare reform although now its got stuck in the legislative process. How

Obama can claim that he can provide cover for 46 million more people without increasing costs is beyond

me and Doug Elmendorf, the Director of the Congressional Budget Ofce. In a letter written to Kent

Conrad, the Chairman of the Committee of the Budget on 16 June 2009 he commented:

Many proposals to signicantly expand insurance coverage would add to federal costsDepending on

the specic policies selected, the added cost could be on the order of $100 billionWe do not see the

fundamental changes that would be needed to reduce federal spending by a signicant amount and, on the

contrary, the legislation signicantly expands the federal responsibility for healthcare.

Elmendorf got summoned to the White House afterwards. Vice President Joe Biden has been canvassing

support and at an AARP (American Association of Retired Persons) town hall meeting argued that if nothing

is done about the unfunded healthcare liabilities (total US government unfunded liabilities are c.US$60trn)

Were going to go bankrupt as a nation.

Biden is correct, but the problem is the nonsensical solution currently being proposed:Now, people when I say that look at me and say, What are you talking about, Joe? Youre telling me we

have to go spend money to keep from going bankrupt? The answer is yes, thats what Im telling you.

As Mish (Mike Shedlock) commented on his Global Economic Trend Analysis website:

This is reminiscent of the My Lai massacre and the destruction of various Vietnamese villages in the

Vietnam War. An American major said after the destruction of the Vietnamese village Ben Tre: It became

necessary to destroy the village in order to save it.

I was also amused to watch California x its US$26bn budget decit problem. Part of the x comes from

the possibly illegal withholding of US$2bn in taxes from local jurisdictions (e.g. cities) and what looks like

about US$1.5bn from moving the last payday for state employees in the current nancial year into the

next. California, like the federal government and, therefore, the US dollar is living on borrowed time.

Since the last Thunder Road, we have gained some important new insights into the gold and silver

markets. First, how about this for an admission from a former insider? Ronald Reagans Assistant Treasury

Secretary, and reputed to be the Father of Reaganomics, Paul Craig Roberts, said in the bi-weekly paper,

Counterpunch:

The price of 1-ounce gold coins is $1,000 despite efforts of the U.S. government to hold down the gold

price. How high will this price jump when the rest of the world decides that the bankruptcy of the worlds

only superpower is at hand?

How high indeed! His downbeat comments on the structure of the US economy apply equally to the UK:

There is no economy left to recover. The U.S. manufacturing economy was lost to offshoring and free

trade ideology. There is no economy left to recover. It was replaced by a mythical New Economy. The New

Economy was based on services. Its articial life was fed by the Federal Reserves articially low interest

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rates, which produced a real estate bubble, and by free market nancial deregulation, which unleashed

nancial gangsters to new heights of debt leverage and fraudulent nancial products. The real economy

was traded away for a make-believe economy. When the make-believe economy collapsed, Americans

wealth in their real estate, pensions, and savings collapsed dramatically while their jobs disappeared.

Craig Roberts has been on blinding form recently. One of my key themes recently has been the countdown

to a dollar crisis and here is part of an interview Craig Roberts did with the broadcaster, Max Keiser:

Max Keiser: Quick question. What should the Treasury Secretary be doing?

Craig Roberts: He should be trying to save the dollar as the worlds reserve currency which means stopping

the wars, reducing the bailout money, and trying to reduce the trade and budget decits in order to save

the dollar. Thats what he should be doing.

Max Keiser: Does the Treasury Secretary work for the people or does he work for the banking system on

Wall Street?

Craig Roberts: He works for Goldman Sachs (well the dark global brotherhood of transnational money

interests, Paul).

Gerlald Celente, of the Trends Research Institute, was brilliant on the Financial Sense news hour this week

discussing increasing anger of ordinary people with the current state of affairs:

As we say in the trends business, there are three worlds out there. Theres the media world, theres the

political world and theres the real world. And the media world and the political world are totally out of touch

with whats going on in the real world. This is just the beginning.

And:

The Americans can make fun of the French all they want, but the French workers stand up and the French

people stand up (Youve got to love the French in this regard action not apathy, Paul). Theres going to

come a time in this country where the people that arent weighed down with junk food and arent Walmartedto death are going to stand up and ght. We are on the cusp of the second American revolution.

This is an interesting point as we watch the Anglo Saxon governments bankrupt themselves. It also ts with

a theme highlighted by Martin Armstrong recently that protest/revolution goes in waves on a GLOBAL basis.

A key theme in my bullish stance on gold and silver is that demand for physical bullion will eventually

overwhelm all efforts by the authorities to suppress gold and silver prices. More indications of the tightness

in gold and silver supply continue to pop up. GATA supporter Dave Kranzler nally received delivery on his

COMEX silver contract:

it took over 6 weeks for HSBC to physically deliver the silver to our fund from our May Comex contract

technically it should have left HSBCs vault on May 29th.

And he did better than other buyers of silver bullion:

the people at our depository - First State in Delaware - told us they have customers still waiting for

delivery of silver on their April contract.

We should also not forget the anecdotal evidence of how COMEX has put pressure on some investors to

settle for cash rather than demanding physical bullion.

Heres another example. Although it was not announced in the press room (sneaky) of the US Mints

website, the Prudent Investor found this elsewhere on the site

Production of United States Mint American Eagle Gold Proof and Uncirculated Coins has been temporarilysuspended because of unprecedented demand for American Eagle Gold Bullion Coins. Currently, all available

22-karat gold blanks are being allocated to the American Eagle Gold Bullion Coin Program, as the United

States Mint is required by Public Law 99-185 to produce these coins in quantities sufcient to meet

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public demandThe United States Mint will resume the American Eagle Gold Proof and Uncirculated Coin

Programs once sufcient inventories of gold bullion blanks can be acquired to meet market demand for

all three American Eagle Gold Coin products. Additionally, as a result of the recent numismatic product

portfolio analysis, fractional sizes of American Eagle Gold Uncirculated Coins will no longer be produced.

As the Prudent Investor asked, why cant the US Mint risk buying the gold it needs in the free market since

it is legally required to sell these coins? Or will it contact the IMF, which is a seller of gold, about an off-

exchange deal although it might be at the back of a long queue of sovereign nations. That said, if history

is anything to go by (like Gordon Brown selling 415 tonnes of our gold to bail out US banks who were the

wrong way in the gold market versus a US$300/oz strike price), the IMF will try to unload it into the

market at the most opportune time like when gold next tests US$1,000/oz.

The whole question of whether gold and silver ETFs are really the equivalent of buying gold bullion surfaced

again with the 13 July 2009 announcement by Greenlight Capital that it had switched out of its 4.2m shares

in the SPDR Gold Trust ETF (known by its ticker as GLD) and into the equivalent amount (nearly US$400m)

of physical bullion. This was a signicant move by a sophisticated investor - Greenlight is a US$5.0bn hedge

fund founded by David Einhorn back in 1996. The question now is whether other large buyers of gold ETFs

will follow suit and move into physical bullion. John Paulson, another huge buyer of GLD, comes to mind.

Coincidently or not, Dave Kranzler (mentioned above) had sent a report outlining his concerns about

investing in gold and silver ETFs to the Greenlight fund on two occasions since February. Several analysts,

starting with James Turk of goldmoney.com and including Kranzler and J.S. Kim have looked at the

prospectuses of major gold and silver and raised legitimate concerns as to whether an investment in the

major gold and silver ETFs are really backed by gold and silver bullion and whether the massive gold and

silver shorts on COMEX are legitimate custodians for the bullion in the biggest gold and silver ETFs since

their identity appears to be the same.

As Ive highlighted in a previous Thunder Road, the delivery notices for gold and silver served on COMEX

bear almost no relation to bullion moving into and out of the dealers inventory. Adrian Douglas, founder ofmarketforceanalysis.com and a director of GATA did some excellent sleuthing on the settlement procedures

on COMEX and found this:

Exchange Rule 104.36, which governs exchange of futures for physicals (EFP) transactions on the COMEX

Division, refers to a physical commodity as one of the required components of an EFP transaction but also

indicates that the physical commodity need only be substantially the economic equivalent of the futures

contract being exchanged.

The purpose of this Notice is to conrm that the Exchange would accept gold-backed exchange-traded

Funds (ETF) shares as the physical commodity component for an EFP transaction involving COMEX gold

futures contracts, provided that all elements of a bona de EFP pursuant to Exchange Rule 104.36 aresatised.

As Adrian Douglas remarks:

The system is the ultimate alchemy. If ETF shares are NOT backed by gold but are accepted by the COMEX

as equivalent to physical gold...presto! You have turned paper into gold - and paper is a lot cheaper than

lead.

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14/14

Author: I started work the month before the stock market crash in 1987. Ive worked mainly as an analyst

covering the Metals & Mining, Oil & Gas and Chemicals industries for a number of brokers and banks

including S.G. Warburg (now UBS), Credit Lyonnais, JP Morgan Chase, Schroders (became Citibank) and,

latterly, at the soon to be mighty Redburn Partners.

Disclaimer: The views expressed in this report are my own and are for information only. It is not intendedas an offer, invitation, or solicitation to buy or sell any of the securities or assets described herein. I do not

accept any liability whatsoever for any direct or consequential loss arising from the use of this document or

its contents. Please consult a qualied nancial advisor before making investments. The information in this

report is believed to be reliable , but I do not make any representations as to its accuracy or completeness.

I may have long or short positions in companies mentioned in this report.

1st august 2009

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