Wednesday, March 16, 2011

Tsunami May Sink the U.S. Dollar and Uranium Sector

What a few days it has been. It was and continues to be a humanitarian disaster of grand proportions - and one that happened on an island where there is more high end video and cellphone cameras than almost anywhere in the world - bringing us photos and videos that are both shocking and incredible.

The Bank of Japan has plunged in as all central banks are wont to do in this day and age, thinking it is somehow "helping" by counterfeiting trillions of Yen, but no amount of money printing can change reality - in fact it can only make things worse at it distorts price signals which investors use to make decisions on where to allocate scarce resources.

We, like most, are dependent on the Japanese Government and major news media for our information on events on the ground in terms of the ongoing nuclear situation in Japan. Things look bad at the moment but may not necessarily be as bad as they seem. This write-up seems to indicate that things are still under control but at this point it is difficult to gauge.

The Uranium Sector

The Dollar Vigilante has had 5% of our portfolio in the uranium sector but the events of the last few days leave our investment thesis for this small part of our portfolio at risk.

Our one main holding, a Uranium Fund, was until recently up 110% since our purchase in September, but with a dip in the price of uranium over the last few weeks and now this ongoing crisis in Japan, it is only up 56% after falling 16% Monday.

The question now is, how do we invest or divest in this sector?
The answer to that remains nebulous and changes on an hour-by-hour basis at the moment.

To put it in its briefest terms possible, from an investment perspective, if there are no major deaths or sickness resulting from this nuclear situation then this should be a major buying opportunity in the uranium sector. However, if things continue to worsen and result in significant deaths or sickness we could be looking at a collapse of a significant percent of the uranium industry. Already environmentalist groups in the UK, US and Germany are lobbying hard to ban all new nuclear reactors.

It really shouldn't be this way. No matter what happens the general public should realize that it was foolish of the Japanese Government to license and subsidize nuclear power stations on one of the most active faultlines on the planet - within striking distance of a tsunami no less. It also will likely go without notice that most of these plants are four decades old and were already set to be decommissioned.

But no one said that anything to do with the nuclear industry has ever been rational. Three mile island caused a total of zero deaths and yet it almost destroyed the entire nuclear industry. Even Chernobyl, which was the only really serious nuclear accident in history, caused only 57 immediately attributable deaths - although many more deaths are attributable after the fact mostly due to countless errors by the Ukrainian SSR at the time.

The point is, however, that Three Mile Island, alone, with zero attributable deaths, nearly shuttered the entire industry. And so, with disaster on a razor's edge in Japan at the moment, a large percent of the industry, at least for the next decade or two, lies in the balance.

As investors, our educated guess just turned into a roll of the dice. Luckily, for us, our investment in this sector was only 5% of our portfolio so even a total loss - something we don't expect - would not be devastating.

Each investor has to make their own decision. We have not sold our uranium holdings and have been adding to one holding in particular today which we just released to TDV subscribers. It is a company with "uranium" in its name which has seen its stock knocked down from $1.23 to $0.91 just because of its name. However, the company itself actually holds cash and stock in a lithium company worth $1.20 per share and recently picked up a high grade silver property in Argentina - all of which you can currently buy at a 25% discount solely due to investor panic.

Repercussions for US Treasuries and the Dollar

All major markets including gold are down significantly today as investors become skittish.
The most important aspect of this entire situation, however, is that the Japanese Government will need to sell a large quantity of its horde of US Treasuries to pay for reconstruction.

With China not adding to its holdings of US Treasuries, the Arab oil exporters looking more volatile every day and now Japan looking as though it may be an active seller that doesn't leave many buyers left for US Treasuries except its biggest holder and sole-buyer of nearly all new issuances from November until at least June - the Federal Reserve.

We'll be covering this in much more depth in the April issue of TDV but with the Bank of Japan printing trillions of Yen and the US Treasury market becoming even more of a one-buyer market (the Federal Reserve itself), the investment positions we hold in gold and gold stocks look to be set for further major gains once the short term panic subsides.

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Checking in on Relative Gold

Relative Gold is also known as the real price of Gold. Its essentially a comparison of Gold against various asset classes. Why is this important? There are two reasons. First, the real price of gold tends to lead leverage performance (e.g the HUI/Gold ratio). Second, the real price of Gold often provides hints of the future direction of the nominal price of Gold.

Keep in mind that Gold is the type of asset class that performs best when its strongly outperforming the other asset classes. This seems like an obvious statement but it is an important one. If stocks or bonds are performing very well then money (usually mainstream) flows into those asset classes and not Gold. If conventional asset classes perform well, there is little reason for the masses to go into Gold.

In the chart below we show Gold against various asset classes. Gold has made a new high in nominal terms but hasn't held it. One reason why could be the weak performance of Gold against stocks, currencies and commodities. In recent months, money has flowed into those markets and not Gold. Gold made marginal highs against both bonds, but with risk aversion increasing and a possible US Dollar rally, how long will that last?

Gold's real performance is mixed which suggests a sustained breakout in nominal terms is unlikely at present. Gold has started to outperform stocks and commodities and we expect that to continue. However, there is a clear divergence with Gold priced in other currencies, which suggests that recent US Dollar weakness has buoyed Gold. While struggling, the US Dollar has yet to break support.'s public opinion is only 31% bulls for the US Dollar.

When many markets are in flux as is the current situation, intermarket analysis becomes all the more important. Comparing markets against each other helps us decipher the leaders, the winners and the laggards. The current picture for Gold is mixed but could become more clear if/when the greenback confirms its bottom. We would welcome that as it would clear out the last of the weak hands and position Gold ready to move higher.

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Japan's Earthquake Hidden Nuclear Catastrophe

Yoichi Shimatsu writes: News of a third explosion at the Fukushima nuclear power plant sent stocks plunging on the Nikkei exchange which dropped 1,015 points on the session. After 2 days of battering, the stock index is off more than 1,600 points in its worst performance since Lehman Brothers failed in September 2008.

Japanese Prime Minister Naoto Kan has ordered the evacuation of all people living within a 18 mile radius of the power station and warned homeowners to remain indoors to avoid contact with "elevated levels of radiation".

"Substantial amounts of radiation are leaking in the area," Kan said in an emergency broadcast on television at 0200 GMT.

Already, the disaster at Fukushima is the second biggest nuclear catastrophe on record, just behind Chernobyl, but reactor volatility suggests that the problem could persist for some time to come, perhaps months.

According to CBS News: "A fire at a fourth reactor in a quake-damaged nuclear plant sent radiation spewing into the atmosphere Tuesday. Earlier, a third explosion at the plant in four days damaged a critical steel containment structure around another reactor, as Japan's nuclear radiation crisis escalates dramatically....

Making matters worse, the wind over the radiation-leaking nuclear plant in northern Japan will blow inland from the northeast and later from the east on Tuesday, the Japan Meteorological Agency said, according to Reuters. Harmful radiation can spread via wind and rain.

At a shelter in Sendai, workers told CBS News that everyone must avoid Tuesday's rain, as it carries nuclear radiation. Low-level radioactive wind from the nuclear reactor in Fukushima could reach Tokyo within 10 hours, based on current winds, the French embassy says. Radiation at up to 9 times the normal level was briefly detected in Kanagawa near Tokyo." ("Japan nuke plant fire leads to spewing radiation", CBS News)

The magnitude of the crisis is hard to grasp. Another two reactors saw their cooling systems breakdown late Monday increasing the probability of a meltdown. So far, there have been 4 explosions and 3 fires at various reactors following the devastating 8.9 earthquake and tsunami. 

Hidehiko Nishiyama, an official with the Economy Ministry, issued this warning to people living in the vicinity of Fukushima:

"Now we are talking about levels that can damage human health....Please do not go outside. Please stay indoors. Please close windows and make your homes airtight. Don't turn on ventilators. Please hang your laundry indoors."

The radiation level in the capital, Tokyo, was recorded at 10 times normal on Tuesday evening, but the city government said there was no threat to human health. The prevailing winds have since shifted sending the radioactive material out to the Pacific Ocean.

An article in the New York Times suggests that a nuclear meltdown may be less dangerous that the spent fuel rods which are no longer submerged in water. Here's an excerpt from the article:

"The pools, which sit on the top level of the reactor buildings and keep spent fuel submerged in water, have lost their cooling systems and the Japanese have been unable to take emergency steps because of the multiplying crises.

The threat is that the hot fuel will boil away the cooling water and catch fire, spreading radioactive materials far and wide in dangerous clouds....

The bad news is that if efforts to deal with the emergency fail, the results could be worse.
The pools are a worry at the stricken reactors at the Fukushima Daiichi plant because at least two of the three have lost their roofs in explosions, exposing the spent fuel pools to the atmosphere. By contrast, reactors have strong containment vessels that stand a better chance of bottling up radiation from a meltdown of the fuel in the reactor core.

Were the spent fuel rods in the pools to catch fire, nuclear experts say, the high heat would loft the radiation in clouds that would spread the radioactivity.

“It’s worse than a meltdown,” said David A. Lochbaum, a nuclearThe Wave, reminiscent of Hokusai's masterful woodblock print, blew past Japan's shoreline defenses of harbor breakwaters and gigantic four-legged blocks called tetrapods, lifting ships to ram through seawalls and crash onto downtown parking lots. Seaside areas were soon emptied of cars and houses dragged up rivers and back out to sea. Wave heights of up to10 meters (33 feet) are staggering, but before deeming these as unimaginable, consider the historical Sanriku tsunami that towered to 15 meters (nearly 50 feet) and killed 27,000 people in 1896.

Nature's terrifying power, however we may dread it, is only as great as the human-caused vulnerability of our civilization. Soon after Christmas 2004, I volunteered for the rescue operation on the day after the Indian Ocean tsunami and simultaneously did an on-site field study on the causes of fatalities in southern Thailand.

The report, issued by Thammasat and Hong Kong Universities, concluded that high water wasn't the sole cause of the massive death toll. No, it's buildings that kill - to be specific, badly designed structures without escape routes onto roofs or, in our greed for real estate, situated inside drained lagoons and riverbeds, or on loose landfill. In the Tohoku disaster, an ultramodern Sendai Airport sat helplessly flooded on all sides while nearby a monstrous black torrent swept entire houses upstream.

Other threats are built into the vulnerabilities of our critical infrastructure and power systems. The balls of orange flames churning out of huge gas storage tanks in Ichihara, Chiba, should never have happened if technical precautions had been properly carried out. Whenever things go wrong, underlying risks had led to a liability and, in a responsible society, accountability.

Most people assume that the meticulous Japanese are among the world's most responsible citizens. As an investigative journalist who has covered the Hanshin (Kobe) earthquake and the Tokyo subway gassing, I beg to differ. Japan is just better than elsewhere in organizing official cover-ups.

Hidden nuclear crisis

The recurrent tendency to deny systemic errors - "in order to avoid public panic" - is rooted in the determination of an entrenched bureaucracy to protect itself rather than in any stated purpose of serving the nation or its people. That's the unspoken rule of thumb in most governments, and the point is that Japan is no shining exception.

So what today is being silenced on orders from the Tokyo government? The official mantra is that all five nuclear power plants in the northeast are locked down, safe and not leaking. The cloaked reality is that at least one of those - Tepco's Fukushima Nuclear Power Plant - is under an emergency alert at a level indicative of a quake-caused internal rupture. The Fukushima powerhouse is one of the world's largest with six boiling-water reactors. 

Over past decades, the Japanese public has been reassured by the Tokyo Electric Power Company that its nuclear reactors are prepared for any eventuality. Yet the mystery in Fukushima is not the first unreported problem with nuclear power, only the most recent. Back in 1996 amid a reactor accident in Ibaraki province, the government never admitted that radioactive fallout had drifted over the northeastern suburbs of Tokyo.

Our reporters got confirmation from monitoring stations, but the press was under a blanket order not to run any alarming news, the facts be damned. For a nation that's lived under the atomic cloud of Hiroshima and Nagasaki, total denial becomes possible now only because the finger on the button is our own.

People are the best defense

Despite the national addiction to nuclear power that keeps the neon lights bright over Shibuya's famous corner, Japan still remains the most prepared of all societies for earthquakes, tsunami, conflagrations and other disasters. Every work unit, large or small, has an emergency response plan. The Tohoku quake hit on a workday afternoon, meaning the staff in every factory and office could act as a team to quell small fires, shut the gas lines, render first aid and restore their communication system. Even in most homes, residents have a rechargeable flashlight plugged into a socket and emergency bottles of water.

Northeast Japan is better prepared than other localities because in the wake of the Kobe quake in 1995, the regional Keidanren, or federation of industrial organizations, sponsored a thorough risk-management and crisis response study. Tohoku Keidanren staffers, who had known of my reporting on the San Francisco and Kobe quakes, asked me to write an article prioritizing disaster preparedness.

First on my list was a people-based communications network such as the citizen's band radio that enabled Northern Californians to self-organize despite power blackouts. That point directly led to the fast licensing of new mobile phone towers equipped with back-up batteries. Second was independent power generation inside all major factories so that these large facilities could recharge batteries, provide lighting and pump water for their neighborhoods and, if necessary, offer shelter, sanitation and medical care. These systems must be routinely used at least on weekends so that the equipment is regularly checked and the staff stay familiar with their operation.

.Third, and most important, is the ability of individuals to rally as a self-sustaining community. In Kobe, society collapsed under a sense of personal defeat. In San Francisco, by contrast, neighbors reached out as friends and opened their doors, food stocks and hearts to victims and their kin. Without compassion, each of us is very much alone indeed.

As participants in communities, who can suddenly find themselves naked before unthinkable hazards, we must act to defuse the deadly "bomb" that provides us lighting, energy for appliances and air-con. Prevention of the next Chernobyl or Three Mile Island begins when we stop naively believing in the cost efficiency of uranium, and for that matter the cleanliness and healthiness of "clean" coal.

Japan has vast untapped reserves of offshore wind energy, the only practical alternative to nuclear power and fossil fuel. Yet the nuclear lobby, coal companies and oil majors have strong-armed the government and industry to stubbornly refuse to invest in advanced and efficient turbine engineering, including magnetic-levitation rotors that eliminate the need for energy-sapping bearings.

At certain stages of societal evolution, there arrives an unmistakable message to leave behind our worn-out security blanket and surf the wave of the future. The tsunami is just such a signal arising from the ocean's depths to awaken Japan, as a global technology leader, to push much faster into a cleaner, greener and safer world.

Emergency Special Report II

Quake Monitor: Meltdown has started - Saturday 12 March (noon Japan time zone)
Meltdown is underway. Japan's Industrial Nuclear Safety Agency reported that the radioactive isotopes cesium and iodine were detected by a monitoring station in the Fukushima No.1 nuclear power plant. The presence of these substances in air samples is a sure indicator that an uncontrolled chain reaction has started. Overheated uranium rods have eaten through their protective metal casings and have started nuclear fission. The regulatory agency's announcement overturns the earlier claim of plant operator TEPCO that all uranium rods were intact.

The National Institute of Radiological Science, in Chiba outside Tokyo, has flown a team of doctors and nurses by helicopter to a health center 5 km from the Fukushima plant to monitor nuclear exposure in workers, emergency crew and local residents. 

Nuclear workers, who this morning restarted the pumping of cold water into the reactor, are being hampered by aftershocks of larger than Richter 6. Plant operator TEPCO ordered the release of steam from the overheated reactor this morning because internal pressure is twice higher than the allowable limits of the original facility design. Plant officials say that the steam is being filtered of radioactive particle. Outside the plant, however, the monitoring station detected outdoor radiation levels 8 times higher than normal, indicating either leakage or filter malfunction.

Three of the six reactors of the TEPCO Fukushima Nuclear Power Plant, were operating at the time of the Tohoku quake. The failure of back-up generators caused significant rise in temperatures inside No.1 (46 MW output) and No.2 (784 MW) reactors. 

The Japanese government overnight dispatched truck-mounted power generators to both plants in order to restart cooling pumps. On-site back-up batteries that run the control system were depleted of power within 8 hours of the blackout. Authorities are now locating robots to dispatch for remote control repairs to the reactors because the interior is unsafe for human employees.

Impact on North America: 

The Pacific jetstream is currently flowing due east directly toward the United States. In the event of a major meltdown and continuous large-volume radioactive release, airborne particles will be carried across the ocean in bands that will cross over the southern halves of Oregon, Montana and Idaho, all of California, Nevada, Utah, Colorado, Wyoming, the Dakotas, northern Nebraska and Iowa and ending in Wisconsin and Illinois, with possible further eastward drift depending on surface wind direction. 

Most of the particles can be expected to travel high in the atmosphere, with fallout dependent on low pressure zones, rainfall and temperatures over the US. If a meltdown can be contained in Fukushima, a small amount of particles would be dispersed in the atmosphere with little immediate effect on human and animal health.

Another climate factor to be taken into account is the potential for an El Nino Variable bulging the jetstream further northward, causing fallout over western Canada and a larger number of American states. 

Seasonal rainfall over Japan does not normally begin until mid-April and does not become significant until early June. 

If very high radiation releases are detected at some point, a potential tactic to lessen contamination of North America is for the US, Canadian and Russian air forces to seed clouds over the northwest Pacific to create a low pressure front and precipitation to minimize particle mass reaching North America.

Japan, the Persian Gulf and Energy

Over the past week, everything seemed to converge on energy. The unrest in the Persian Gulf raised the specter of the disruption of oil supplies to the rest of the world, and an earthquake in Japan knocked out a string of nuclear reactors with potentially devastating effect. Japan depends on nuclear energy and it depends on the Persian Gulf, which is where it gets most of its oil. It was, therefore, a profoundly bad week for Japan, not only because of the extensive damage and human suffering but also because Japan was being shown that it can’t readily escape the realities of geography.

Japan is the world’s third-largest economy, a bit behind China now. It is also the third-largest industrial economy, behind only the United States and China. Japan’s problem is that its enormous industrial plant is built in a country almost totally devoid of mineral resources. It must import virtually all of the metals and energy that it uses to manufacture industrial products. It maintains stockpiles, but should those stockpiles be depleted and no new imports arrive, Japan stops being an industrial power.

The Geography of Oil

There are multiple sources for many of the metals Japan imports, so that if supplies stop flowing from one place it can get them from other places. The geography of oil is more limited. In order to access the amount of oil Japan needs, the only place to get it is the Persian Gulf. There are other places to get some of what Japan needs, but it cannot do without the Persian Gulf for its oil.
This past week, we saw that this was a potentially vulnerable source. The unrest that swept the western littoral of the Arabian Peninsula and the ongoing tension between the Saudis and Iranians, as well as the tension between Iran and the United States, raised the possibility of disruptions. The geography of the Persian Gulf is extraordinary. It is a narrow body of water opening into a narrow channel through the Strait of Hormuz. Any diminution of the flow from any source in the region, let alone the complete closure of the Strait of Hormuz, would have profound implications for the global economy. 

For Japan it could mean more than higher prices. It could mean being unable to secure the amount of oil needed at any price. The movement of tankers, the limits on port facilities and long-term contracts that commit oil to other places could make it impossible for Japan to physically secure the oil it needs to run its industrial plant. On an extended basis, this would draw down reserves and constrain Japan’s economy dramatically. And, obviously, when the world’s third-largest industrial plant drastically slows, the impact on the global supply chain is both dramatic and complex.

In 1973, the Arab countries imposed an oil embargo on the world. Japan, entirely dependent on imported oil, was hit not only by high prices but also by the fact that it could not obtain enough fuel to keep going. While the embargo lasted only five months, the oil shock, as the Japanese called it, threatened Japan’s industrial capability and shocked it into remembering its vulnerability. Japan relied on the United States to guarantee its oil supplies. The realization that the United States couldn’t guarantee those supplies created a political crisis parallel to the economic one. It is one reason the Japanese are hypersensitive to events in the Persian Gulf and to the security of the supply lines running out of the region.

Regardless of other supplies, Japan will always import nearly 100 percent of its oil from other countries. If it cuts its consumption by 90 percent, it still imports nearly 100 percent of its oil. And to the extent that the Japanese economy requires oil — which it does — it is highly vulnerable to events in the Persian Gulf.
It is to mitigate the risk of oil dependency — which cannot be eliminated altogether by any means — that Japan employs two alternative fuels: It is the world’s largest importer of seaborne coal, and it has become the third-largest producer of electricity from nuclear reactors, ranking after the United States and France in total amount produced. One-third of its electricity production comes from nuclear power plants. Nuclear power was critical to both Japan’s industrial and national security strategy. It did not make Japan self-sufficient, since it needed to import coal and nuclear fuel, but access to these resources made it dependent on countries like Australia, which does not have choke points like Hormuz.

It is in this context that we need to understand the Japanese prime minister’s statement that Japan was facing its worst crisis since World War II. First, the earthquake and the resulting damage to several of Japan’s nuclear reactors created a long-term regional energy shortage in Japan that, along with the other damage caused by the earthquake, would certainly affect the economy. But the events in the Persian Gulf also raised the 1973 nightmare scenario for the Japanese. Depending how events evolved, the Japanese pipeline from the Persian Gulf could be threatened in a way that it had not been since 1973. Combined with the failure of several nuclear reactors, the Japanese economy is at risk.

The comparison with World War II was apt since it also began, in a way, with an energy crisis. The Japanese had invaded China, and after the fall of the Netherlands (which controlled today’s Indonesia) and France (which controlled Indochina), Japan was concerned about agreements with France and the Netherlands continuing to be honored. Indochina supplied Japan with tin and rubber, among other raw materials. The Netherlands East Indies supplied oil. When the Japanese invaded Indochina, the United States both cut off oil shipments from the United States and started buying up oil from the Netherlands East Indies to keep Japan from getting it. The Japanese were faced with the collapse of their economy or war with the United States. They chose Pearl Harbor.

Today’s situation is in no way comparable to what happened in 1941 except for the core geopolitical reality. Japan is dependent on imports of raw materials and particularly oil. Anything that interferes with the flow of oil creates a crisis in Japan. Anything that risks a cutoff makes Japan uneasy. Add an earthquake destroying part of its energy-producing plant and you force Japan into a profound internal crisis. However, it is essential to understand what energy has meant to Japan historically — miscalculation about it led to national disaster and access to it remains Japan’s psychological as well as physical pivot.

Japan’s Nuclear Safety Net

Japan is still struggling with the consequences of its economic meltdown in the early 1990s. Rapid growth with low rates of return on capital created a massive financial crisis. Rather than allow a recession to force a wave of bankruptcies and unemployment, the Japanese sought to maintain their tradition of lifetime employment. To do that Japan had to keep interest rates extremely low and accept little or no economic growth. It achieved its goal, relatively low unemployment, but at the cost of a large debt burden and a long-term sluggish economy.
The Japanese were beginning to struggle with the question of what would come after a generation of economic stagnation and full employment. They had clearly not yet defined a path, although there was some recognition that a generation’s economic reality could not sustain itself. The changes that Japan would face were going to be wrenching, and even under the best of circumstances, they would be politically difficult to manage. Suddenly, Japan is not facing the best of circumstances.

It is not yet clear how devastating the nuclear-reactor damage will prove to be, but the situation appears to be worsening. What is clear is that the potential crisis in the Persian Gulf, the loss of nuclear reactors and the rising radiation levels will undermine the confidence of the Japanese. Beyond the human toll, these reactors were Japan’s hedge against an unpredictable world. They gave it control of a substantial amount of its energy production. Even if the Japanese still had to import coal and oil, there at least a part of their energy structure was largely under their own control and secure. Japan’s nuclear power sector seemed invulnerable, which no other part of its energy infrastructure was. For Japan, a country that went to war with the United States over energy in 1941 and was devastated as a result, this was no small thing. Japan had a safety net.

The safety net was psychological as much as anything. The destruction of a series of nuclear reactors not only creates energy shortages and fear of radiation; it also drives home the profound and very real vulnerability underlying all of Japan’s success. Japan does not control the source of its oil, it does not control the sea lanes over which coal and other minerals travel, and it cannot be certain that its nuclear reactors will not suddenly be destroyed. To the extent that economics and politics are psychological, this is a huge blow. Japan lives in constant danger, both from nature and from geopolitics. What the earthquake drove home was just how profound and how dangerous Japan’s world is. It is difficult to imagine another industrial economy as inherently insecure as Japan’s. The earthquake will impose many economic constraints on Japan that will significantly complicate its emergence from its post-boom economy, but one important question is the impact on the political system. Since World War II, Japan has coped with its vulnerability by avoiding international entanglements and relying on its relationship with the United States. It sometimes wondered whether the United States, with its sometimes-unpredictable military operations, was more of a danger than a guarantor, but its policy remained intact. 

It is not the loss of the reactors that will shake Japan the most but the loss of the certainty that the reactors were their path to some degree of safety, along with the added burden on the economy. The question is how the political system will respond. In dealing with the Persian Gulf, will Japan continue to follow the American lead or will it decide to take a greater degree of control and follow its own path? The likelihood is that a shaken self-confidence will make Japan more cautious and even more vulnerable. But it is interesting to look at Japanese history and realize that sometimes, and not always predictably, Japan takes insecurity as a goad to self-assertion.

This was no ordinary earthquake in magnitude or in the potential impact on Japan’s view of the world. The earthquake shook a lot of pieces loose, not the least of which were in the Japanese psyche. Japan has tried to convince itself that it had provided a measure of security with nuclear plants and an alliance with the United States. Given the earthquake and situation in the Persian Gulf, recalculation is in order. But Japan is a country that has avoided recalculation for a long time. The question now is whether the extraordinary vulnerability exposed by the quake will be powerful enough to shake Japan into recalculating its long-standing political system.

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Crop prices collapse amid panic over Japan crisis


"Panic selling" gripped agriculture markets on Thursday, sending corn down the maximum allowed by the Chicago exchange, as the escalating Japanese nuclear disaster gripped investors.
Wheat tumbled 6% on both sides of the Atlantic, while Chicago soybeans fell 4% to their lowest in three months, and corn locked down the 30 cents maximum allowed by the exchange.
Torrid Tuesday - agricultural futures at the close
Chicago wheat: $6.67 ¾ a bushel, -7.4%
Chicago corn: $6.36 a bushel, -4.5%
Chic soybeans: $12.70 a bushel, -5.2%
Paris wheat: E203.00 a tonne, -6.3%
New York cotton: 190.94 cents a pound,    -3.5%
New York cocoa: $3,255 a tonne, -4.0%
New York raw sugar: 25.72 cents a pound, -7.7%
Prices given for May contracts
Among soft commodities, sugar led the decline, plunging 7% to levels not seen since November, with cotton prevented by losses of more than 7.0 cents a pound by New York exchange limits.
The declines followed further setbacks at Japan's stricken Fukushima plant, where problems have now been reported at all six reactors.
"The market just about had the measure of the earthquake and tsunami. But nuclear meltdown is a whole different ball game," a London trader told
US broker US Commodities said: "A knee-jerk reaction to Japanese nuclear explosions has caused panic selling in the commodity world."
Oil was also lower, despite concerns over unrest in Bahrain, while copper fell to a three-month low, and tin plunged 7%.
Scare stories
There were few estimates on the specifics of how Japan's catastrophe would affect crop markets, although US Commodities reported talk that with "northern ports damaged" the country's imports of corn, largely from America, may fall.
"A drop of 1m-2m bushels per week over the remaining 24 ½ weeks of the marketing year would be 25m-50m bushels, alleviating some of the tightness in the US balance tables," the broker said.
However, investors were bombarded with a barrage of broadly bearish talk, including rumours that a further earthquake was a strong possibility, and of estimates of declines of up to 8% in Japan's economic growth this year.
"We now have a warning of further earthquakes and potential Tsunami over the next 24-48 hours," Jaime Nolan at FCStone's European offices said.
At Illinois-based Powerline Group, Darren Dohme said: "The cost of the clean up will run on for decades.
"The country has so much debt that it doesn't have the ability to barrow the billions/trillions it is going to take to clean up and rebuild."
Wheat rally over? 
On wheat, Mr Dohme added that Chicago's May contract had broken a key support area at $6.80 a bushel "even in the face of the worst [winter] wheat crop ratings in modern times," with data overnight showing only a marginal improvement in parched seedlings in Kansas, America's top growing state.
"Is this a signal that the world is done buying this major food crop?"
Sugar's particular decline reflected weak technical factors, with the sweetener's decline over the last month already having investors worried that further declines were in the offing, Stefan Uhlenbrock at FO Licht said.
"Fundamentally, there is no reason for this," Mr Uhlenbrock said.
"But some participants were nervous already. Sugar has come down quite a bit from its peak in February."

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Uranimum/Nuclear ETF Holdings

by Bespoke Investment Group

Market Vectors has an ETF (NLR) that tracks the main uranium/nuclear stocks around the world.  As shown in the chart below, the ETF is down 16% so far this week.

The holdings in NLR come from France, Canada, Japan, Australia, and the US.  Below we highlight these holdings, and we include each stock's country of origin, weighting in the ETF, and performance over the last week.  The uranimum exploration and mining companies have been the ones getting hit the hardest over the last week.  Uranium Resources (URRE) here in the US is down the most of all the ETF's holdings at -41.63%.  Canada's Hathor Exploration (HAT) is down the second most at -40.47%, followed closely by Uranium One (UUU).  One company in the ETF is up over the last week, and would you believe it is a company from Japan?  Kajima is a general contractor that builds commercial, residential, and institutional buildings with high-rise and earthquake-resistant construction technology, including nuclear power plants. 

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Japan sells 20 yr paper/ECB/Bahrain

By Peter Boockvar

Anticipating what lies ahead for Japan in funding a rebuilding over the next few yrs with the backdrop of an already highly indebted balance sheet, investors demanded the highest yield since Mar ’10 in buying a 20 yr bond auctioned off today in Japan. The bid to cover was solid at 4.13 vs 2.64 in Feb but the yield of 2.13% compares with 2.05% last month. Hours after the auction, Fitch said there was “no immediate impact on Japan’s ratings from the earthquake” and their “ongoing ability to fund itself in local markets at low yields is a crucial support for the ratings at their current levels and so far, there has been limited impact on sovereign funding conditions.” This self funding mechanism that Japan has blissfully had in the past will of course be highly scrutinized going forward. Asian stocks did bounce led by Japan and copper rose to a 1 week high in response, now back above the pre earthquake level on rebuilding bets.

We heard from the FOMC yesterday and as expected they will continue on their current course but the question that the Japanese disaster has brought to the ECB and BoE is more difficult to answer. One clue that maybe the ECB won’t go ahead with a rate hike that has been well telegraphed by Trichet and other members was a comment from ECB member Noyer to a German newspaper where he said “we will, as always, consider all new information, and that will be part of our global assessment.” This and a Moody’s downgrade of Portugal has the euro lower after its big rally off its lows vs the US$ yesterday. The Moody’s downgrade just has its new rating in line with S&P so thus provides very little new information. In the Middle East, Bahrain halted trading in its stock market due to rising unrest and Libya continues to bomb itself. Oil is bouncing in response.

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Japan Quake: Interactive Before and After Satellite Photos

By Barry Ritholtz

Amazing before and after photos via German news magazine Spiegel of numerous Japanese towns and cities. (Can anyone translate the headline/sub hed for me, or point to an English language version?)

In the interactive version, you can grab a slider and run it across the full photo:

click for interactive version

Hat tip Edward T

Emergenza Giappone: aiutiamoli subito

Disponibile anche in: English, Deutsch

Sendai Oil Refinery Fire, Sendai, Japan

way home - getting creepy
Food Shopping
hotel lobby at night
Tutto il mondo sta pensando e pregando per le popolazioni affette dal terremoto in Giappone. Da Venerdì scorso, quando il Paese è stato colpito dal disastro, si sono registrate migliaia di vittime e mezzo milione di persone sono state evacuate e sono costrette in ripari di fortuna.

Gli utenti della community in Giappone stanno documentando la situazione e ci permettono di conoscere la dimensione del disastro.

Se desideri prestare aiuto, scopri come inviare le tue donazioni.

Inserita da Federico Bierti

Fed Makes No Mention of Japan.

Federal Reserve policy statements are supposed to outline the forces that will drive monetary policy over coming months, so while it wasn’t unexpected, it’s nevertheless puzzling central bankers omitted the biggest risk of all: Japan.

It is true economists are still trying to come to terms with the fluid and very unpredictable course of events coming out of Japan in the wake of last week’s earthquake and tsunami, which has turned into a humanitarian catastrophe and metastasizing nuclear disaster. No forecasters can say with any reliability what impact Japan will have on the world economy, or on the U.S. economy.

And yet, for a Fed that likes to weigh all the risks to the outlook, one of the biggest ones out there is the impact Japan might have on the U.S. Economists have flagged the automotive and technology sectors as potential problem spots, but Japan’s tragedy has the potential to go further and strike at financial markets. That could have knock-on effects on the growth outlook and how the Fed pursues monetary policy.

As it stands now, Fed policy makers see a recovery standing on “firmer footing” amid labor markets that are “improving gradually.” While it expects inflation to remain contained, it nevertheless notes rising commodity and energy prices are “putting upward pressure” on inflation, even as policy makers see the gains as “transitory.” Most Fed watchers had anticipated the Fed would say that, as much as they also saw the central bank continuing forward with its $600 billion bond-buying program.

Fed watchers looked to what the central bank said and saw it as evidence the Fed is growing more confident in the recovery. “Our expectation for a mid-2012 rate hike is not changed by this statement” and “it does point to the Fed beginning the baby steps required to exit from its current strategy,” said Eric Green of TD Securities.

And yet, Japan has the potential to change this outlook, in very significant ways. For one, the powerful downdraft swamping global markets is a problem for the Fed. If stock prices fall significantly, the Fed may have to react by providing more economic stimulus. Central bank officials have pointed to the rise in equity prices since embarking on QE2 as a signature success of the policy. If stocks were to fall a lot, the impact on confidence and wealth would have to be taken into account by policy makers, given the central role officials like Fed Chairman Ben Bernanke have granted markets.

More broadly, if supply-chain disruptions proved truly profound and wounded the auto and technology industries, they could blunt or end the powerful round of growth seen over recent months. Factories, even at their relatively small share of U.S. output, have been a major engine of the recovery, so weakness there would be worrisome for the broader course of the move out of recession.

Continued Japan problems could change the Fed outlook in other ways. Fed officials Tuesday flagged their awareness of the impact energy was having on pushing up inflation. But oil prices have fallen as Japan’s problems have grown. Perhaps, demand for oil will now be weaker and reduce the brewing inflation problem central bankers acknowledge.

None of this is to say there’s been a big shift in the odds the Fed will continue QE2 beyond its currently stated target. But as much as anything mentioned in the Fed statement, the unacknowledged problems in Japan could be a big influence on monetary-policy decisions over coming months. Said RBS Securities analysts: “The uncertainty generated by recent developments in Japan gives the Fed even more reason to show patience. Indeed, it is possible lingering uncertainty could push back the timetable for Fed action.”

Economists are currently split over the impact Japan might have on the U.S. Deutsche Bank economists said in a research note “the possible effects on the U.S. economy from the earthquake in Japan appear less damaging than the recent weakness in U.S. markets would imply.”

But not everyone agrees with that view. Japanese events, along with political unrest in the Middle East, are a potential game changer, warns Bernard Baumohl of the Economic Outlook Group. “The first two weeks of March unleashed a fusillade of geopolitical and natural shocks the likes of which we haven’t seen since World War II,” he said, noting “the shocks will ripple through the world economy for years to come.”

U.S. Macro in Two Simple Charts

By Global Macro Monitor

To understand the U.S. economy go no further than the following two charts.  In 2009 and 2010, public sector borrowing was more than 100 percent of total net domestic credit flows.  Federal government borrowing was 93 percent of these flows.   The chart also shows the incredible collapse of U.S. credit bubble.

Private sector deleveraging peaked in Q1 2010 and net consumer credit in Q4 was positive for the first time since Q2 2008.  Net mortgage flows remain negative and corporate credit flows are picking up stream.

The first chart illustrates why the U.S. money supply has not exploded even though the Federal Reserve has almost tripled the monetary base.  The second chart shows why inflation concerns are increasing, however, as domestic credit markets heal and are primed with a massive arsenal high powered money.


by Cullen Roche

Chatter of a commodity bubble has increased in recent months as prices surge higher on a daily basis.  But one question dominates the debate – if there really is a bubble when could it end?   I have estimated that it would not be shocking to see the commodity bubble coincide with the end of QE2.  But Ray Dalio believes it could have much more life in it.  In this weekend’s Barrons Dalio said the commodity bubble was likely to persist into 2012:
The commodity bubble continues?
It continues until China and those countries become too tight, and that’s probably not until late 2012. Not only are they going to buy commodities, they are going to buy the commodity manufacturers, because there is only a certain amount of inventory of actual commodities they can hold. They are also going to buy other kinds of companies, instead of being exposed to bonds denominated in our depreciating money. You are going to see China and other creditor countries buy more assets in the U.S.

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By Vitaliy Katsenelson, CFA

Stocks are allegedly cheap now, at 15.7 times 2010 earnings. And they are cheap by historical standards. Only 10 years ago, their price/earnings ratios were double today’s; they are even cheaper if you compare their forward (2011) earnings yield of 7.3% to the 10-year Treasury yield of 3.40%. They are cheap, cheap, cheap!

Or so we’ve been told.

Unfortunately, the cheapness argument falls on its face once we realize that pretax profit margins are hovering close to an all-time high of 13.3% (the all-time high was 13.9% in 2007), almost 58% above their average of 8.4% since 1980. Once profit margins revert to their historical mean, the “E” in the P/E equation will decline. If the market made no price change in response, its P/E would rise from 15.7 to 24.9 times trailing earnings.
Many disagree that profit-margin reversion will take place. Here are their most common arguments, and some food for thought on why this supposed common sense doesn’t translate to sensible logic.

Who said that margins have to revert to a mean; why can’t they just remain high?

“Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system and it is not functioning properly.” – Jeremy Grantham
Profit margins revert to the mean not because they pay tribute to mean-reversion gods, but because the free market works. As the economy expands, companies start earning above-average profits. The competition reacts to fat margins like bees sensing sugar water. They want some, so they fly in and start cutting into these above-average margins.

What about the billions of dollars U.S. companies poured into technology – weren’t they supposed to make their operations more efficient and bring higher profit margins?

Those billions of dollars did not go to waste; companies are more productive now than ever before. Efficiency gains stemming from productivity were a source of competitive advantage and higher margins when access to proprietary technology was a competitive advantage.  For example, Wal-Mart’s rise in the retail industry was achieved through a very efficient inventory-management and distribution system that passed cost savings to consumers and drove less-efficient competitors out of business.

Today, however, that same – or even better – technology is available off-the-shelf to retailers like Dollar Tree and Family Dollar, whose outlets are about the same size as a couple of Wal-Mart restrooms put together. Oracle or SAP will gladly sell state-of-the-art distribution/inventory software systems to any company able to spell its name correctly on a check. Increased productivity didn’t and won’t bring permanently higher margins to corporate America – the consumer is the primary beneficiary of lower prices. If profit margins didn’t respond as they do, Wal-Mart’s net margins would be 25% today, not 3.5%.

Over the past 70 years, growth in corporate earnings and GDP haven’t differed significantly. On the other hand, there has been a permanent benefit from increased operating efficiency: It lets companies hold less inventory and adjust more quickly and precisely to changes in demand. This has led to less volatile GDP.

Shouldn’t average profit margins be higher now, as the U.S. economy has transitioned from an industrial (low-margin) economy to a service (higher-margin) economy?

It is not as much of a change as we might think. In 1980, services represented about 51.3% of GDP. After 30 years and a lot of changes like outsourcing, services have increased to 65.3% of GDP. If we assume that the service sector has double the margins of the industrial sector (a fairly conservative assumption), increases in the service sector should have boosted overall corporate margins by about 40 to 80 basis points above their 30-year average – to between 8.8% and 9.2%, but still far below today’s 13.3% margin. Thus, if we adjust corporate margins to reflect the transformation toward a service economy, corporate profit margins are still 45% above their long-term mean.
Shouldn’t globalization allow U.S. companies to increase margins?

A larger portion of U.S. companies’ profits is coming from overseas than ever before. However, globalization is a double-edged sword – U.S. companies are expanding and will continue to expand overseas and capitalize on new opportunities. But as the world flattens, they also face new competition at home and abroad. For example, Motorola – a company that used to represent American might in the telecommunications arena – has been marginalized in the U.S. and around the world by companies whose names we didn’t recognize 15 years ago – Finland’s Nokia and South Korea’s Samsung. (It’s very interesting how much the smartphone industry has changed in three years:

Apple, a company I did not even mention in my 2008 article, has transformed the industry. Motorola, which was almost dead then, is coming back to life. Nokia is becoming irrelevant very quickly, and LG and HTC are important players.)

Although Wal-Mart is rapidly expanding overseas, it will soon face a new breed of competition. U.K. retail giant Tesco recently entered the American market (Cisco Systems has been successful in Asia, but its home turf has been attacked by the Chinese company Huawei.)  U.S. companies may get a larger portion of their earnings from overseas (the weak dollar will help), but they’ll have to fight to defend home turf.

International expansion doesn’t guarantee fatter margins;  quite the opposite: We are facing competition from countries such as Korea and China that may be more concerned with increasing market share, even at the expense of short-term profitability.

Higher oil prices are here to stay, so maybe multiyear higher margins in the energy sector are here to stay as well.

This would be the case if energy companies sold their products to customers in another galaxy where somebody else bore all the costs of high-energy prices. Petroleum products are consumed by corporations and individuals. The benefits of higher profit margins to the energy sector are achieved at the expense of lower margins for companies that consume their products – which is the rest of the corporate world, to varying degrees.

Today’s stock valuations are a lot higher than it appears if you normalize earnings to lower profit margins. And while it’s hard to tell when earnings will embark on a fateful journey to their historic mean, competitive forces will make that happen sooner than later. Earnings will either decline or grow at much slower pace than GDP.

Companies that don’t have a sustainable competitive advantage will not be able to keep their competition at bay, and will face margin compression, along with lower earnings growth or declining earnings. Look at your portfolio: Can the companies whose margins are hitting all-time highs sustain them?

Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo.  He is the author of The Little Book of Sideways Markets (Wiley, December 2010).  To receive Vitaliy’s future articles by email, click here or read his articles here. .

Robust (above-average) earnings growth from the depth of a recession creates a false appearance, usually reflected in forward earnings estimates, that earnings can and will grow at a faster rate than the economy for a long period of time – but they don’t (see chart below, the growth of $1 of earnings and GDP from 1950 to 2010).  For earnings to grow at much higher rate than the economy (GDP) for a long time, profit margins have to keep expanding, and as I’ve discussed in the past, capitalism (i.e. competition) doesn’t allow that to happen.


Looks to me like the lack of noises out of Japan means there won’t be a sufficient fiscal response to
restore demand.  If anything, the talk is about how to pay for the rebuilding, with a consumption tax at the top of the list. That means they aren’t going to inflate. More likely they are going to further deflate.

Yes, the yen will go down by what looks like a lot, maybe even helped by the MOF, but I doubt it will be enough to inflate. In fact, all the evidence indicates that Japan doesn’t don’t know how to inflate, nor does anyone else. Worse, what they all think inflates, more likely actually deflates.  0% rate policies mean deficits can be that much higher without causing ‘inflation’ due to income channels and supply side effects.

There is no such thing as a debt trap springing to life. Debt monetization is a meaningless expression with non convertible currency and floating fx. QE mainly serves to further remove precious income from an already income starved economy. Only excess deficit spending can directly support prices, output, and employment from the demand side, as it directly adds to incomes, spending, and net savings of financial assets.

The international fear mongering surrounding deficits and debt issues is entirely a chicken little story that’s keeping us in this depression (unemployment over 10% the way it was measured when the term was defined) that’s now taking a turn for the worse. The euro zone is methodically weakening it’s ‘engines of growth’- its own (weaker) members being subjected to austerity measures that are reducing their deficit spending that paid for their imports from Germany.  And now China, Japan, the US and others will be cutting imports as well. UK fiscal austerity measures are accelerating on schedule. The US is also working to tighten fiscal policy, particularly now that both sides agree that deficit reduction is in order, beaming as they make progress towards agreeing on the cuts.

The US had 6 depressions while on the gold standard, which followed the only 6 periods of budget surpluses.

And now, even with a floating fx policy and non convertible currency that allows for immediate and unlimited fiscal adjustments, we have allowed the deflationary forces unleashed by the Clinton budget surpluses to result in this 7th depression. We were muddling through with modest real growth and a far too high output gap and may have continued to do so all else equal. But all else isn’t equal. Collective, self inflicted proactive austerity has been working against growth, including China’s ‘fight against inflation.’

And now Japan’s massive disaster will be a deflationary shock that, in the absence of a proactive fiscal adjustment, is highly likely to further reduce world demand. Hopefully, the Saudis capitulate and follow the price of crude lower, easing the burden somewhat on the world’s struggling populations. If so, watch for a strong dollar as well.

And watch for a lot more global civil unrest as no answers emerge to the mass unemployment that will likely get even worse.  Not to mention food prices that may come down some, but will remain very high at the consumer level as we continue to burn up our food supply for motor fuel. And it’s all only likely to get worse until the world figures out how its monetary system actually works.

* Warren Mosler is currently the President of Valance Co, Inc. & a founder of Illinois Income Investors that evolved into the III investment companies. III was rated number one by MAR in risk adjusted returns for the previous 10 years in 1997 when he turned control over to his partners.

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