Friday, May 24, 2013

There Is Now a 100% Chance of a Market Collapse

There Is Now a 100% Chance of a Market Collapse:
This article has been reprinted with permission from Stansberry and Associates and appeared at The Daily Crux.
From Porter Stansberry in The S&A Digest:
As you undoubtedly know, financial newsletter writers get paid to make bold, exciting predictions. Judging by the hyperbole in our industry’s sales letters, you’d have to imagine that we’re all bipolar. After all, according to newsletter writers, the world is always either about to end… or about to boom.
Today’s Friday Digest is no different. In fact, what I would like to show you today is without a doubt the single greatest threat to your wealth you will ever face. Even so, I’m confident almost all of you will ignore this warning until it is far, far too late. And that’s at least partly my fault. So before we get to the finance, I’d like to share something about my own company that I don’t like and wish I could change.
The reality is, the terrible things and incredible booms we predict (almost every day) in the sales presentations for our newsletter business rarely come to pass. I’d like to think our sales presentations are better than my fellow publishers… but truthfully, I’m pretty sure an outsider wouldn’t be able to tell the difference. So how can you tell when a newsletter writer’s dire warnings or emphatic recommendations are real… or at least likely to turn out to be right?
As you would imagine, I have some insight into this question. After all, I have written some of the most famously hyperbolic headlines of all time in our industry. Some of these predictions turned out to be right, like when I predicted Fannie Mae and Freddie Mac were going to zero.
New subscribers might rightfully wonder why a newsletter publisher (like me) would write such things about his own work and draw attention to the occasional excesses in his company’s marketing. Why would I remind our clients of the single biggest weakness of our business model – our need for hyperbolic sales pitches?
What can I say? I can’t help myself. I feel an obligation to tell you what I’d like you to tell me, were our roles reversed. That’s why I write the Friday Digest. I firmly believe that if you combine the strategies I explain in these notes with our investment research, you will excel as an investor. And then you’ll forgive us for the hyperbole required for our marketing.
In fact, I know thousands and thousands of investors around the world have used our work to become world-class investors. They depend on us for reliable and profitable ideas. When I meet them, they always ask… “Why do you people use such terrible marketing?” Well, we use what works. We assume, were you in our shoes, you’d do the same.
Sadly, though… perhaps because of our marketing, most of the people who try one of our investment newsletters either demand a refund or simply allow their subscription to lapse. The main reason that happens is because the reason they subscribed – the original hyperbolic headline – did not pan out the way they expected. (Or at least it didn’t pan out soon enough to suit their desires for the end of the world or the beginning of a new boom.)
Even worse… when the facts change, we’re likely to change our minds. But… nothing costs you more in publishing. That’s a fact. I can’t explain it… but it is the truth. Likewise, nobody wants to read that their cherished financial nonsense is going to come to a bad end. I can’t count the number of Peak Oil believers who’ve sent me angry demands for a refund – never mind the soaring oil and gas production numbers. Or the latest craze: digital currency Bitcoin. Just mentioning that Bitcoin might turn out badly will likely cost me several thousand subscribers. I’m not kidding.
So… how can you know when a newsletter writer is going to be right about an outlandish prediction… perhaps one that goes against your own beliefs about the market? In my opinion, the best guide is history. When history says the prices in a market have gotten completely out of whack, the newsletter writer is going to be right every time. If history isn’t your bag, you can look at the data and the trends and remember your statistics lessons: the central tendency, reversion to the mean. Let me give you one recent example from these pages.
About a year ago, I made an “outlandish” prediction – that natural gas prices were going to go up and oil prices were going to come down…
There are few things in life I know with certainty… But I know this: Barring the end of the world, the price of oil is going to fall and the price of natural gas is going to rise.
At the time, natural gas producer Chesapeake was collapsing because of low natural gas prices and nearly everyone on Wall Street was short natural gas. I recommended buying Chesapeake bonds and its competitor, Devon, and I predicted a huge rebound in natural gas prices.
In fact… I guaranteed that natural gas would soar because I knew it was certain – a 100% chance – that natural gas couldn’t continue to trade for less than $2 per thousand cubic feet (MCF). A year later, the price of gas has doubled. How did I know?
A barrel of oil contains 5.825 million British thermal units (Btu) of energy. One thousand cubic feet of gas contains just a little more than 1 million Btu. Thus, a barrel of oil has approximately six times more energy than 1 million cubic feet of gas. On an energy-equivalent basis, you would expect natural gas to trade for one-sixth the price of oil. But of course, oil is more highly prized as a fuel source. It’s more easily portable and thus is a better fuel for transportation.
Historically, looking at the two commodities, the average multiple of gas to oil was about 10x. That is, a barrel of oil was, on average, 10 times more expensive than one thousand cubic feet of gas. By last April, that premium had reached an all-time high of 55 times.
There was no way that kind of price relationship could have lasted. A reversion to the mean was 100% certain. And that’s what happened. Today, with West Texas Intermediate crude oil at $95 per barrel and natural gas at around $4, the ratio is still wide, at almost 24 times. But it’s half as wide as last year. You should expect oil prices to continue to decline and gas prices to continue to rise. I believe the future 10x equilibrium will be reached when gas is around $6 and oil is around $60.
Now… let me give you another “outlandish” prediction. The U.S. bond market – particularly junk bonds – is going to crash. When this crash occurs, it will be the largest destruction of wealth in history. There has never been a bigger bubble in U.S. bonds.
How do I know? It’s simple. Junk bonds (aka high-yield bonds issued by less creditworthy companies) have never yielded less than 5% annually. But they do today. Likewise, the difference between the yields on junk bonds and the yields on investment-grade bonds has almost never been smaller. That means credit is more available today than almost ever before for small, less-than-investment-grade firms. The last time credit was this widely available – and at such low costs – was in 2007. And you know how that turned out…
The coming collapse in the bond market will be far worse than it was last time, too. This time, the Federal Reserve’s actions have driven forward the huge bull market in bonds. The Fed is printing up almost $100 billion per month and buying bonds. That has forced the other buyers of bonds to buy riskier debt that, historically, offered much higher yields.
Today, those yields have been incredibly “compressed.” You can imagine the high-yield segment of the bond market to be like a spring whose coils have been driven together by the force of the Federal Reserve’s market manipulation. As soon as the Fed’s buying stops (and it must stop one day, or else it will trigger hyperinflation), the yields on those riskier bonds will soar again. As bond yields rise, the price of bonds will fall sharply.
To give you a specific example, car manufacturer General Motors recently issued bonds to investors. The yield on these securities was only 3.25%. I’m fairly certain that inflation in our economy will exceed that rate.
That’s why a company that went bankrupt in the last five years… that operates in a highly competitive market… and still suffers from massive overcapacity… is paying essentially nothing for capital. That doesn’t make any sense. Investors are being paid nothing, in real terms, for their savings – or to accept the real risk that GM could default. Investors ought to be getting at least 7.5% on these bonds, a yield that would cause the price of these bonds to fall 50%.
I believe we’ll see a real panic in the corporate bond market at some point in the next year. I expect the average price of non-investment-grade debt (aka junk bonds) to fall 50%. Investment-grade bonds will fall substantially, too. (I’d estimate something around 25%.) This is going to wipe out a huge amount of capital… and believe me… it’s 100% guaranteed to happen.
The Daily Crux Note: Porter recently released a report he’s been working on for the past ten years… and if you own gold – or are considering buying it today – you should drop everything and read it now. In short, he says you could become “unbelievably rich” or “disastrously poor,” based on one simple gold decision almost everyone gets wrong. Click here to see the full report for yourself.