The Stock Market Deception

Bill Bonner - Wed 20 Jan, 2010

It's a depression held up by loose monetary policy which will eventually underpin this economic demise

Waterford, Ireland

Does the stock market know something we don’t?

Yesterday, investors bid up prices on the Dow stocks to a new high. The index rose 115 points.

According to theory, the markets know more than any single investor, analyst or economist. In theory, the markets know everything there is to know. In theory, the markets are always right.

But what the heck? This is the same stock market that signaled clear sailing ahead ten years ago. Soon after, equities hit an iceberg. They sank for the next decade.

Here at the Daily Reckoning, we had our own views. At the beginning of the ‘00s, we told readers to sell their stocks. We were right. The stock market was wrong. Heh heh.

So, who ya gonna trust now? The stock market…? Or, the Daily Reckoning?

Who knows. Maybe we’re wrong this time, but we see another 10 years of trouble coming. Two years ago, the credit cycle peaked out. After half a century of adding debt, the private sector had had enough. Borrowing turned down. Last November, it registered its 10th month in a row of declines, something that had never happened since they began keep records after WWII.

Consumer spending has held up surprisingly well. But with credit contracting and unemployment high and rising, it can’t continue.

Small businesses create jobs. But who wants to take the risk of funding a small business now? Not the banks. And the capital markets are closed off to small businesses. You have to have a big business, preferably one that is dying... then, you can get all the money you want from Wall Street and the feds.

Since the downturn began 2 years ago, 7.5 million jobs have been lost. There is no sign that they will be found anytime soon. Jobless people do not spend a lot of money. Ergo, you can’t really expect an economic surge until people get jobs.

When will that happen? Possibly years from now... maybe 2... maybe 5... maybe 10…
Yes, dear reader, we are in a depression. It is a period of adjustment... of correction... of de-leveraging... of paying down debt. And there’s not much the feds can do about it – except disguise it... delay it... and make it worse.

The government can spend money. The government can inflate the currency. But it’s neither government spending nor inflation of the currency that makes an economy healthy. If inflating the currency could make an economy prosper, where did Zimbabwe go wrong? And if government spending could boost an economy, what did Cuba do wrong? Or Venezuela? The two-bit, banana republic economies are almost all burdened by too much government stimulus. The feds tax too much, spend too much, borrow too much and inflate too much. Instead of doing their jobs – enforcing property rights, protecting people from crime, and staying out of the way – they meddle and spend. The president gets a fancy house and lots of security guards. And the economy rots.

Of course, we could be wrong about what is happening in the US. But our guess is that the stock market is wrong instead. Stock market investors anticipate a return to ‘normal.’ But the normal they’re looking at is a very unusual credit bubble that blew up and can’t be mended. The real normal is what we’re getting. And the real normal is a world where bad stuff happens. Investors make mistakes. Markets make mistakes. Often, they are misled by their own financial authorities, such as Ben Bernanke. The US Fed chief meddles in the economy and distorts the picture. Investors look, but get the wrong idea.

Our guess is that stock market investors are seeing the distorted picture caused by the feds’ meddling... not the real picture. They look. They see low interest rates. They see stimulus. They see a stock market that seemed so friendly and so rewarding for so long that they can’t imagine anything else. They see a government taking action... and making things better. They read Thomas Friedman and think the ‘political class’ can fix whatever problems it encounters.

But in the real world, the political class is a life-threatening parasite. Allow it to grow large enough and the host – the private economy – will shrivel up and die.

And in the real normal world, markets go up... and then they go down. We are in one of those periods of decline. We are in a depression, with a growing, parasitic political class. This phase won’t end any time soon…

More news from London...

Bringing cut and polished diamonds to the market takes a lot of time, Tom Bulford tells us in his latest Penny Sleuth.

And central to the process are the diamantaires – the people who take the rough diamonds and turn them into jewellery.

“It is a special skill,” explains Tom, “passed down from father to son. Several generations of the same family have peered and squinted through eyeglasses, cut and polished the gems and muttered ‘very nice, very nice’.”

And whilst the art of creating these sought-after, sparkling rocks is satisfying work for the people who do it, it all depends upon the wheels of finance. And as you can imagine, that’s made diamonds a tough business in the past couple of years.

“The diamantaire must pay for the rough diamonds long before he can sell the finished jewel,” Tom tells us. “It is a textbook example of an activity that requires working capital. The banks must lend the diamantaire the money to buy the rough diamonds. They must then wait to be repaid.

“But in the last two years this was not happening. The mechanism broke down. The banks refused to offer credit. Diamantaires were unable to buy rough diamonds. And so the price of rough diamonds collapsed.”

But… here comes the money point, dear reader:

Now banks are lending again, the diamond sector is hot…

Let us allow Petra Diamonds (ticker: PDL), one of the world’s leading suppliers of rough diamonds, to expand…

‘Confidence has returned to the rough diamond market, with financing now beginning to open again…the second half of 2009 saw the return of many of the more cautious participants to the market and Petra noted a strong increase in attendance at our tenders. Certainly levels of competition for rough diamonds are now much closer to normal levels and serve to underpin the stability of the market.’

Translation from our man, Tom: “… the diamond business is rapidly staging a comeback, and investors should take note.

“Remember this. While demand for diamonds rises inexorably there are very few places in the world that have the geological characteristics that could conceivably host diamonds. Most of these have already been exploited.

“In the long term demand is set to exceed supply. And in the short term, confidence is returning to the market. Share prices of diamond producers are rising fast. In the last month African Diamonds (ticker: AFD) is up 43%, and Namakwa Diamonds (ticker: NAD) is up 33%.

“But there is another share that has done even better – and could yet have a long way to run. In the January issue of Red Hot Penny Shares I featured this company. In the same issue I also gave a special briefing on the obscure, but highly profitable world of diamonds.”

You can still get hold of this issue of Tom’s Red Hot Penny Shares. Read all about Tom’s diamond story – plus two other exciting natural resource based companies. To find out how to get it, click here.

Red Hot penny Shares is a regulated product issued by Fleet Street Publications ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you’ve bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3600.

And more views:

*** Gary Shilling is probably right. He says to buy Treasury bonds and the dollar. They’re both probably going up this year.

Why? Because we are in a depression. And when investors finally realize it they will seek safety. They will buy US Treasury bonds, raising prices and lowering yields. Those Treasury bonds are in dollars, by the way. Investors will want dollars.

There are two main emotions that drive investors – fear and greed. Lately, greed drives them to buy emerging markets, stocks generally, and commodities. Fear drives them to dump all their risky investments and head for cover. They believe cover is found in the dollar and in US Treasury bonds – traditionally, the world’s safest credits.

*** “ Ireland has changed so much,” said a colleague at last night’s dinner. He was speaking early in the evening. Later, we went to Henry Downs’ place... where the #9 whisky is as smooth as a baby’s derrière. We can’t remember what happened after that.

“The Irish had big families. Every one had five or six children. We were a big exporter of people. People were our major export. And of course, the world is fully of mics and paddies. America, Canada, Australia, New Zealand... but there are also a lot of Irish in Argentina.

“Birth control was illegal. I remember when I was 16... I had a friend who wanted to sleep with his girlfriend. Since I was tall and looked older he asked me to go into a pharmacy and buy condoms. It was so awkward. I waited until there were no other customers in the shop. Then, I went in... .trying to make my voice lower than it really was... and asked the middle aged woman behind the counter for condoms. It was so embarrassing. It’s a wonder people had sex at all.”

“People in Ireland are still funny about sex,” said another Irish colleague. “My boyfriend and I ‘lived in sin’ before we got married. Everybody knew it. But ‘living in sin’ was not just a joke. People thought it was a real sin. They didn’t really mind it, but they expected us to pretend we weren’t sinning. So when my parents would visit we had to pretend we had separate bedrooms... even though it was obvious we were sleeping together.

“But nowadays, it’s different. Now couples only have one or two children.”

Until tomorrow,

Bill Bonner
The Daily Reckoning

P.S. We recommend you take a moment to review Tom Bulford’s work on the diamond sector. No one’s talking about it, but it could be a big story in 2010. You’ll get Tom’s latest issue, which details the background to the sector PLUS his top way to play it, when you take a look at his excellent small cap newsletter. Details are here.

Red Hot penny Shares is a regulated product issued by Fleet Street Publications ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you’ve bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3600.

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