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Mark's Market Blog

5-7-11: The Silver bubble bursts.

By Mark Lawrence

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Stocks and everything else nose-dived this last week, finally recovering a bit on Friday. Silver dropped from $50 to $30. Oil dropped from $114 to $95 before recovering a bit to $97. This nosedive was not due to any particular news item or change in the world economy, it was simply the bursting of a small bubble in Silver. Expect more of these over the course of the next couple of years. Cheap, easy money has inflated lots of little balloons all over the place, and a few really big balloons, like Chinese real estate. Lately money has been rushing into short-term t-bills, raising their prices and thereby dropping interest rates. I take this as a sign that more and more people are preparing for a big stock market decline after QE2 ends on June 30.

S&P 500 November 7 2010 to May 6 2011

This week I'm feeling a bit dumb. Last week I noted that Sunday night silver had dropped by 15% in a few hours. I didn't think that through. Traders had been building what are called "pyramids" in commodities: they buy future contracts. The commodity goes up. They use their profits to double down, buying even more futures. It goes up some more, they buy some more. This is a bubble. The drop in silver was the popping of this little bubble. The result was some traders losing a lot of money as the cash calls came in. To cover their losses, they had to sell lots of stuff: silver, gold, copper, oil, stocks. I should have recognized this immediately and sold nearly everything I have Monday morning, to be bought back at a 5% or so discount a few days later. Instead I ignored it - I own no silver - so now I'm down for the week. Stocks will recover in the next week or two and, I believe, continue on to new highs over the next few weeks, but I had all the information in my hands in a timely fashion to make a good, profitable decision and I missed it completely.

Silver, April 7 to May 6 2011. A 30% drop in one week.

One year of Oil to May 6 2011. A 15% drop in one week.

How far has the mania for commodities gone? Search on EBay for "copper bar." I got 2260 results. There is a booming industry in 1 pound .999 pure copper ingots. I find this interesting: you can learn how to easily and cheaply test the purity of gold in your own kitchen, but testing copper to be sure there's no zinc, nickel, iron mixed in? Difficult. Still have that embarrassing bomb shelter in your back yard? Fill it with copper bars, turn it into your own private copper mine. Perhaps one day Walmart will take payment for groceries in copper ingots.

How's the economy doing? Well, it's split in two. The top 20% is doing pretty well. I have nothing to complain about - Consumer Reports says that motorcycle sales are up due to gas prices. My sales of motorcycle windshields are certainly up. But how about the other 80% of everyone? Here's some chilling numbers:

New unemployment claims are up, up a lot. New jobs are also up a lot. It's a bit confusing looking at the raw numbers. The new jobs are mostly relatively low quality - called "McJobs" by some. The statistics are if you haven't had a job in six months, you're not going to get one. Right now it seems we're in the process of taking about ten million construction workers and turning them into people who sleep on park benches. If you step back and graph the numbers, we continue on our slow multi-year slog back to normalcy.

Michigan has passed a law that allows financially troubled cities, towns, and school districts to be taken over by state-appointed emergency managers. The law gives those managers broad and controversial powers, including the authority to void union contracts and remove elected officials. It allows private consultants and restructuring experts an opportunity to do to distressed cities what they've done to distressed companies. "Ninety percent of the law is an early warning system," says Representative Al Pscholka, who sponsored it. "The fundamental point is that if the municipality had made the hard choices there would be no need for an emergency manager." Senator Jack Brandenburg of Harrison Township put it more bluntly: Emergency managers would be deployed as a last resort in communities that need "financial martial law." On April 14, Joseph Harris, the emergency manager of Benton Harbor (population 11,000), test drove his new powers by stripping all of Benton Harbor's elected officials of what remained of theirs. "The local elected officials constantly passed resolutions against Harris. They threatened lawsuits. They impeded his ability to do the job," says Pscholka, who represents the area that includes Benton Harbor. "Harris put them in the timeout chair." "Within constraints, government should be run like a business," says Edward Plawecki, who helped organize a training program for emergency managers. "Officials should look at health-care and retirement costs, workers' comp and benefits, and see what best practices might be applied to their municipalities."

The U.S. Department of Education sent a letter to districts around the country Friday, reminding them that all students, legal or not, are entitled to a public education. The letter comes amid reports that schools may be checking the immigration status of students trying to enroll, and reminds districts they are federally prohibited from barring elementary or secondary students on the basis of citizenship status. "Moreover, districts may not request information with the purpose or result of denying access to public schools on the basis of race, color or national origin," said the letter, which was signed by officials from the department's Office of Civil Rights and the Department of Justice. I think more and more states are going to get backed into a fiscal corner and follow in the footsteps of Arizona and Oklahoma, making it very difficult for illegals to stay in their state. The illegals will then move from AZ and OK to more welcoming states like CA and TX, backing them into a fiscal corner. I also think, were I president, that the two DoEs - education and energy - would be not much longer for this world.

The Chinese run a rather closed society, so my feelings about their economy are mostly just that: feelings. It's hard to get reliable statistics out of the middle kingdom. But there's lots of anecdotes. Here's the latest: the government, this year, has cracked down on real estate loans to try to slow the rather obvious bubble in apartment prices. To get around this, people are going to their bank and borrowing tens and hundreds of millions of dollars to purchase metals, like copper. They buy the copper and put it in a warehouse. Then they go to a second bank, show them the copper, and get another loan based on that. With the second loan they buy or build real estate. One of my Fillipino friends says, "I've seen that before," with a rather chilling smile.

Recently someone added everything up and announced that all the real estate in Beijing was worth a full year of US GDP. This is eerily reminiscent of Japan in the late 80s when the real estate around the royal palace in Kyoto was worth all of California and the real estate in Tokyo was worth the entire US. We all know how that ended: Japan crashed and still hasn't recovered 20 years later. Remember, just before their crash Japanese were flying here and buying up skyscrapers and houses at hugely inflated prices, sold back a couple years later for 20 cents on the dollar. If you read about Chinese flying here and overpaying for buildings and mansions, feel free to smile. It seems to me that at this point the Chinese are convinced their economy can never sputter or go into recession. Markets have a way of re-educating those with such beliefs. I'm not predicting a 20 year recession for China, but the idea of a crash that leads either to their government falling or militarizing seems more likely every month to me. When that happens, given the Chinese propensity to use the rich and educated as scapegoats, I would not care to be a Chinese millionaire, and I especially would not want to be one driving around in a Ferrari with a wife dressed in Gucci and Prada. Bullets are just under a nickel in China, so Chinese millionaires will be valued at about 60 cents per dozen. Judging from the emigration statistics, apparently about a quarter to a half of Chinese millionaires agree with me.

Portugal almost has a new (populace crushing) bailout. Greece adamantly denies rumors that they will leave the Euro and return to the Drachma; a Greek bond default is now considered inevitable. Interest rates for both countries continue to climb. Ireland is continuing to complain about the terms of their bailout, and has leaked that during initial negotiations last year the European offer included 30B euros of debt relief, but US Secretary Geithner vetoed this as his view is banks always come before the public. Jim Rodgers said this week that he considers a bailout for the UK inevitable. Europe looks a little shakier each day. The Euro continues to be very strong - nearly $1.50 - which is exactly the opposite of what the troubled countries need, but exactly what the US wants. The tension between the rich northern countries and the massively indebted southern countries continues to grow. If this were a marriage, it would be between one person who works hard and saves, and another who ran up massive secret credit card debt. I'd easily predict a legal separation followed by a divorce. But it's countries and politicians and bankers and banker's lackeys, so it will be drawn out until the very bone marrow has been sucked out of the PIIGS.

There are currently three economic power centers in the world, the US, Europe, and China/Japan. Japan has already been tamed. China looks more and more each day like they're painting themselves into a corner, and the US is throwing kerosene on the banking fires of Europe. It has become apparent to me that Washington and New York are working towards a world-wide economic/banking crisis that will leave the US the last man standing, just as it was in the 50s

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