Monday, January 6, 2014

The Fed Is Playing Global Pump-and-Dump

People often criticize me for objecting to the Federal Reserve’s Quantitative Easing (QE) and Zero Interest-Rate Policy (ZIRP) on the grounds that they are setting the stage for hyperinflation and a dollar collapse. Since neither has arrived—yet—people mock me, often pretty badly: “Hey Lira! How's that 2% ‘hyperinflation’ working out for ya!

“The left side reminds me of Dow Jones.”
“Hmm! There does seem to be
a family resemblance . . .”
Funny-funny hardy-har-har.


But even if you don’t buy that QE and ZIRP will lead to a dollar collapse, you do have to admit that these Fed policies have severely brainwashed investors.

Why ‘brainwashed’? Because today, due to the Fed’s policies, stock prices are booming—we’re about to crack 16,500 on the Dow Jones, NASDAQ is well on its way to 4,200, and the S&P is close to 1,850—all record highs.

What’s wrong with record highs? What’s wrong with booming stock prices? Absolutely nothing—unless you look at the two-year charts and realize that these three indices are not reflecting a robust, booming economy. Rather, they have had unrelenting climbs that have been openly—and exclusively—caused by QE and ZIRP.

Which has brainwashed investors into dismissing value. Today, all investors are momentum-chasing pump-and-dumpers who are not worrying about fundamentals, or worrying about the long-term health and well-being of a company.

All they have been brainwashed into caring about is the rise in a stock’s price.

Which is pretty funny, if you think about it: These investors might shun penny-stocks, they might buy and sell stocks by way of “respectable” brokerage houses—but these investors are behaving exactly like the suckers taken for a ride by sketchy boiler rooms operating out of north Jersey.

And we all know how those poor saps usually end up: Broke, holding on to worthless stock certificates not worth the paper they’re printed on.

Why is this happening? Easy, because of the Fed’s QE and ZIRP have so flattened the yield curve across Treasuries and the rest of the bond markets, that anything yielding better than 5%—in any asset class, not just bonds—quickly gets priced up.

They call Treasuries the “benchmark” for a reason: As the (supposedly) safest asset class, they set the yield curve for all assets in all classes—not just in other bonds, but in equities and real estate as well. If Treasury yields are minimal, then a “normal” yield in a riskier asset class will also be minimal.

Look at the following chart:

Click to enlarge.

These are the Top 20 Dow Jones stock as measured by expected stock dividend yields for 2014. The mean of these Top 20 is 3.16%, the average 3.28%.

Now, these are the bluest of the blue-chips—repeat, the Top 20 as measures by yield. If you get dividends of 3.28% on these blue-chip stocks, and pay an income tax rate of say 35% combined State and Federal, you’re looking at a yield of 2.13%.

That’s yearly. That’s less than inflation.

So why are the yields on these oh-so-blue-chips so low? Because of QE and ZIRP’s unrelenting asset price inflation. That’s why you have companies like twitter—which does not have any income to speak of—with a market valuation of $38 billion or whatever.

Since nothing yields a healthy 6% or better, the only thing investors care about today is whether the price of the asset they “invest in” will rise within the year—so that they can sell it at a profit.

That’s not investing—that’s speculating.

By the way, unrelenting asset price inflation was the whole point of the Federal Reserve’s policies. Yeah, I know I went overboard with the combined bold-italics-underlined thing, but I just wanted to emphasize that point, and one other:

The Federal Reserve is the boiler room operation that has pumped up the equities market by way of QE and ZIRP. You are investing in a pump-and-dump scam. And like in all such scams, you will lose.

Clear enough for ya?

Crazy as this may sound, when you look at those measely yields for the Top 20 performer, you realize that investors for the time being are acting rationally: Since yields are minimal—in fact negative, after you factor in income tax and inflation—it pays investors to speculate, rather than to properly invest. Not only are the Fed’s policies goosing the equities markets, the tax code privileges speculators as well, by way of a capital gains tax rate which is lower than the income tax rate. You pay less taxes if you speculate than if you invest responsibly. (!)

Thus both the Federal Reserve and the IRS are encouraging speculation. That’s how investors have become brainwashed: They think that this low-yield, high-asset price inflation, low-capital gains tax environment is the way things ought to be.

But even though the Fed is deliberately, openly goosing the market, no different from a Jersey boiler room operation, nobody’s complaining—or even realizing it—because at this time, investors are making money with this Global Pump-and-Dump.

It ought to be beautiful, right? Everybody making money, all happy in the world. Only problem is, these pump-and-dum scams always end. When do they end? When people stop believing in the hype. When people realize that the global economy is in the toilet, companies are not booming but barely getting by, and there’s nothing on the horizon which will restart the economy. When people—and not a lot of people, mind you, just a tipping point estimated at about 10%—realize that this game that the Fed is playing with QE and ZIRP is a game of musical chairs.

That’s when the Fed’s Global Pump-and-Dump Scam will blow up.

You don’t think as I do that QE and ZIRP will lead to hyperinflation and dollar collapse? Fine, that’s cool—but admit that these Fed policies are skewing the market: They are turning investors into speculators—scratch that, brainwashing them into gamblers.

And it will all end in tears—these schemes usually do. I for one am keeping an ear on this game of musical chairs, trying to anticipate when the music will stop.

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  1. Gonzalo,

    wouldn't the dollar collapse lead to massive buying of eurozone debt and euros as well? Because during crises, some say, commodities plunge because of the declining economic activity. And look at what happened after Cyprus, they say: the euro strongly rose!

  2. I love your sense of humor and the logic of your opinions. I'd venture to say that the vast majority of SMART private investment money is OUT of the market, has been for awhile. Institutional investors are holding their nose and plowing on, simply because seeking that ever-elusive commission check requires them to take ever greater risks.

    When they inevitably collapse they will take all the savings of retirees and pensioners along with them. I see Civil War or a massive Police State (or BOTH?) within the next 5 years.

    1. Yeah, we agree with you, that is me and our unseen fearful rulers with our guns and ammunition and in their case, armored personnel vehicles, drones, universal surveillance, and militarized cops dressed in over the top costumes.

  3. Gonzalo, I think I have many good explanations for hyperinflation using different theories and wonder if you could take a look at them:

  4. And, the International Central Bankers, who gave us ALL the -ism's, like Communism, Socialism, Fascism, don't really care, BECAUSE, they REMAIN IN CONTROL of the debt-based currency called the "Federal" "Reserve" Note, that is currently still the sole World Reserve Currency, and they can INFLATE the "money" supply, to prop up the NYSE, or any market they wish, and provide Crony Banker Bailouts to themselves, and anyone else they deem TBTF ("Too-Big-To-Fail"), causing INFLATION, which means rising food, and gas prices, and lowered purchasing power, as well as lower real incomes, for everyone else. In late 2008, what did they do? (IE, What did the International Central Bankers - who own and operate the so-called "Federal" "Reserve" do?) They stole TRILLIONS of hard-working Americans' $$, and gave it to themselves, and their Crony Central Bankers (in both the U.S., and Europe), a "debt" which will need to be paid back to the SAME G*@-D@%&#) F#(%!^@ CENTRAL BANKERS, which they call the "National Debt". It's a complete joke. Too bad the joke is on US.

  5. Dear Gonzalo and other friends (including Vincent Cate - Hi Vince),

    Thank you for the logical, rational blog posting above. In the course of today I have read postings similar in tone and value. One of them was on, giving a link to an extended commentary by John Williams, whose is one of the few reliable sources of statistical information on CPI, GDP, and employment. The other is the weekly market comment posted by John Hussman on his mutual fund site.

    I am drawing on 46 years of experience as a fairly consistently successful value investor. My current market profile is similar to those that I held in the 1970s, when I was long physical gold for most of the decade, and in 1987, when I had sold most of my standard long stock positions and had built a substantial position in put options.

    One cannot know for certain when the current delusional stock market posture will end, but it will end, and with a lot of losses by speculators who think that they are investors but lack much knowledge of history or the ability to distinguish between price (what you pay) and value (which is what you get).

    I think that gold, measured in ounces, represents one of the relatively few reliable sources of value now generally available. Most of my holdings were purchased in the $400 to $900 per ounce range starting in 2004, so even with the 2013 drop of 28%, still represent a compounded annual gain in the 8% range.

    At present it is difficult to decide among the best buys available -- physical gold, physical silver, or depressed mining shares. I hate to make tough decisions, so continue steadily buying small amounts of each. One does not know when a bottom has been put in until it has passed, but regular purchases at declining prices will capture part of the nadir.

    Rational investors tend to purchase lowly-valued assets and asset classes.

    Your valuable perspective is greatly appreciated.

    Robert B. Eckhardt

  6. "By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some... Those to whom the system brings windfalls,...become "profiteers," who are the object of the hatred... the process of wealth-getting degenerates into a gamble and a lottery... Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose."

  7. Replies
    1. Tuesday morning 01.07.2014

      My post last night concerned principles of rational value investing, under which one would identify an undervalued asset class (physical gold or silver in bar or coin form denominated in ounces, the relatively slowly increasing supply of which can be compared with the rapidly increasing flood of fiat currency), or mining shares (which can be valued on the extent of claims estimated or proved to various extents, product prices, costs, legal complications, etc.).

      I did not mention a factor that increasingly is obvious in the various market for metals and their derivatives (paper certificates for shares, options, futures, and so on). The additional factor appears to be that people who are manipulating the loci of transactions (which used to be called markets, but it is obvious that markets no longer exist in the traditional sense that , however imperfect, was the state about 25 or so years ago.

      It must be accepted that, in addition to standard valuation principles, many people who influence prices on exchanges have had one or more courses in basic psychology, in which they have become familiar with the principles of operant conditioning, a field more or less begun by B.F. Skinner but elaborated to much more sophisticated extents.

      Wikipedia is a handy source for a summary of much of this work, including:
      "Free-operant avoidance learning

      In this experimental session, no discrete stimulus is used to signal the occurrence of the aversive stimulus. Rather, the aversive stimulus (mostly shocks) are presented without explicit warning stimuli. There are two crucial time intervals determining the rate of avoidance learning. This first one is called the S-S-interval (shock-shock-interval). This is the amount of time which passes during successive presentations of the shock (unless the operant response is performed). The other one is called the R-S-interval (response-shock-interval) which specifies the length of the time interval following an operant response during which no shocks will be delivered. Note that each time the organism performs the operant response, the R-S-interval without shocks begins anew."

      By and large, these principles do work in shaping the behavior of organisms, including humans.

      Directional effects on behavior also can be furthered by manipulating the general rules by which "markets" are operated. A good current example is the various strong sanctions against gold purchase and ownership in India.

      Rational behavior in situations of the sort that now exist seem not to be rewarded. My own experience is that reward for rational behavior can be affected by avoidance of much leverage, and reliance on patience and steady accumulative behavior.

      In these times it is difficult to be certain of very much, but it does seem that in parts of the world (e.g. China), price drops are conditioning expanded purchases of gold. Those practices can be emulated by those in the U.S. and Europe.

      As it is possible to condition the behavior of laboratory rats by operant conditioning, so is it possible to condition the behavior of humans. However, human intelligence allows for a wider range of flexible responses to operant conditioning. Along with patience, creativity will be rewarded.

      Robert B. Eckhardt

    2. Thanks for the post Robert

  8. Just want to point out that QE would not be needed if rich people didn't divert money into dead end investments.

  9. Well said. Looks like the Feds decided that Madoff's operating procedures are good enough for them, too. And like Madoff's investors, it'll end the same way. No one complained while the going "appeared" good.

  10. I think gold is the only way in the long run. But to talk about gold giving a yield, is somewhat misleading I would think. Gold is the yardstick, and the anchor. It can thus not give a yield.
    You can only measure paper loss against it. Hard to believe, but true. For it does show you that paper money is declining by far more than official inflation.
    1 OZ in 1971 36$, 1 OZ in 2014 = 1240$ does that not tell the full story!
    Repent, as they used to say! ha ha.

  11. Nasdaq 4,200 wouldn't be close to an all-time high. The Nasdaq went over 5,000 in March of 2000. I agree with much of what you post here, GL, but that's a pretty careless mistake.

  12. All good, as far as the commentary is concerned, but it didn't answer the question as to ~why~ the Fed is forcing people to 'speculate'... I take it that's understood, or are we leaving a key element out of the discussion for a particular reason?

    Aside from keeping member banks solvent by levitating asset prices, are there any other reasons why the Treasury, at the direction of the ESF, are maintaining their interest rate swap derivative programme...?

    All eyes seemed focused on the Fed - when in fact, other equally - if not more so influential entities, have this market effectively 'captured'...

    What's missing...?

    1. You wrote: “[Your post] didn't answer the question as to ~why~ the Fed is forcing people to 'speculate'.

      The reason is, the Fed wants asset prices to rise so that bank balance sheets appear healthier than they in fact are, and because the Fed wants ordinary 401(k) holders to feel that their retirement nest egg is growing solidly.


    2. Also if the inflation of all this credit creation can get diverted into assets instead of consumables, it helps keep the CPI low, so gov't doesn't have to increase social insurance payouts.

  13. This note is a reply to Anonymous, who wrote:

    "Just want to point out that QE would not be needed if rich people didn't divert money into dead end investments."

    Part 1:
    I'm not certain that I am reading the above note correctly, and apologize if I have misunderstood its intent. Gonzalo was raising a well justified caution against "investing" in conventional stocks that are highly priced by any objective valuations. See John Hussman's weekly postings on the web site for his fund, and also the extremely sane short essay posted yesterday by Janet Tavakoli on Café Americain. Right now it is hard to hear the fat lady singing because the bell is ringing so loudly.

    It was in this context that I had suggested precious metals and shares of their miners as alternative investments to Dow-type (not to mention social media) stocks. It feels peculiar for me to find myself writing that gold and silver bullion are "undervalued" since in the late 1970s I sold in the $400 to $600 per ounce range most of the gold coin holdings that I had built up over the earlier years of the decade at $35 to $42 per ounce (10X to 15X missed the top but wasn't a bad return over the period). However, to quote that great investment advisor, Dorothy, "Toto, I don't think that we're in Kansas any more." As Dorothy discovered in the course of her own adventure in Oz, in our present environment what used to be "markets" there obviouslyis someone behind the curtain. And that someone and his/her flying monkey assistants are proliferating fiat currencies as if there is no tomorrow. My own sense is that there will be a tomorrow, but we may not like it when it comes in full force. Gonzalo is entirely correct when he says that the Fed is practicing "pump and dump." Against the backgrounds provided by past history and current reality, that is undeniable.

    It is in this environment that gold and silver are undervalued, even at prices of roughly $1200 and $20 per ounce, respectively. I'm not going to attempt a precise figure here beyond "a whole bunch." There are credible, reasoned, estimates in the range of 2X to 5X and beyond. A good source for such estimates is among others.

    Robert B. Eckhardt

  14. Part 2:
    But right now the really exciting place to be allocating capital is in the very low priced gold and silver mining shares. I will not give any names or symbols since I consider it unethical to "talk my book" in a thin market (the bullion markets themselves may be depressed but they are not thin so it is not possible for my sanguine opinion about metals prices to have any influence there). A good source for information on undervalued mining shares is run by Bob Moriarty. Based on some of his examples, yesterday I was initially buying or adding to small positions in mining companies that have promising claims and have more cash in the till than the share prices. Folks, these are classic Graham and Dodd" type situations in which one can build a portfolio of ten or so companies at exceedingly low levels of capital and risk (as long as one can distinguish between quotational risk -- conventional beta -- and business risk). Surely prices can go lower from here, but that should be seen as further buying opportunity. Remember, the most that one can lose on any company is 100% of the invested capital, but as share prices bounce off the current low levels, the gains can be 5X and 10X in short order. This is not a wild, hypothetical projection. I experienced this in the late 1970s (one past example from that time: Consolidated Modderfontein -- in the romantic business of reclaiming South African gold mine slime dams -- went from 50 pence to £5 per share in a year or so).

    In the context of this response, my experience is that gold and silver bullion and shares in the companies that mine them are not "dead end investments." Instead, we are in this situation not because of "rich people" making non-utilitarian asset allocation decisions to metals that have been considered precious for thousands of years, but because the "too big to fail" investment banks not only bought but INVENTED true dead end investments in the form of CDOs and other derivatives. Following the suspension of the FASB regulation that would have forced these instruments to be marked to market, we are in what seems to be a dream world in the pricing of conventional stocks due to the necessarily endless QE, but one that will end in nightmares with a return to reality when it is realized that earnings are insufficient to support valuations. When that happens -- not if, when -- gold and silver (and their miners) will cease to appear as "dead end investments" and instead will prove to have been instruments for capital preservation.

    Instead of criticizing "rich people" for what may seem to an inexperienced person to be indefensible investing behavior, learning how to accumulate, preserve, and grow capital would be a better strategy. The various sites that I mentioned would be good places to start, as would be reading Ben Graham's classic book, The Intelligent Investor.

    Robert B. Eckhardt

  15. Friday 10 January 2014

    Today I am watching the selloff in the general stock market (Dow, S&P, etc.) and a mirror image rise in gold and silver.

    We don't have a television at home, but at the moment am in a hotel room and have turned on a "financial news" channel populated by spokesmodels who are, however charming and well dressed, clueless. They all are trying to explain why the official unemployment rate went down in the face of utterly dismal (but to me not at all surprising) numbers for jobs created.

    Stocks of gold and silver miners are up very modest amounts. As I wrote in an earlier post, I dislike doing things that are hard. The real challenge at the moment is whether to add to holdings of gold and silver bullion, or to allocate increasing incremental amounts to the beaten-down mining shares.

    No one reading this should take my word as a guide to strategy.
    However, no one should skip reading:
    Café Americain
    weekly editorials by John Hussman on his fund web site

    If I were writing carelessly I would characterize the prices of precious metals and their miners as "once in a lifetime" opportunities. But for me this is the second time around. The present situation in the markets represents the 1970s on steroids. Gold really did go up 10X to 15X then, and both silver and mining shares participated. Most young people cannot imagine this happening again. There is no certainty to be had, but the odds are strongly in favor of something along these lines happening.

    Positions now can be built with derisory amounts of capital.

    When prices are low in objectively-measurable historical terms, steady purchases do capture bottoms that will be visible in the rear view mirror that will be afforded by the future.

    Robert B. Eckhardt

  16. Friday 18 January 2014

    This is an old thread and probably not read any more.

    However, just for the record, more than a week ago I pointed out at some length how value investing principles can be applied to precious metals and shares in the companies that own them.

    The last couple of days have provided strong support for these contentions. There is a long way upward to go upward in these oversold assets, at the same time that the Dow, S&P, etc. remain static or trend downward.

    Robert B. Eckhardt

  17. 24 January 2014

    Gold and miners still have far to go on the upside. Thursday 1.23.2014) was just a hint of what lies ahead.

    Robert B. Eckhardt


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