Friday, April 8, 2011

McAlvany Weekly Commentary

Spring 2011: Speculative Mania Redux?

A Look at This Week’s Show:
-Rampant Speculation is again replacing a common sense approach.
-No one protests free liquidity until it turns into inflation.
-How to have a disciplined approach to your money vs. taking emotionally charged miss-steps.

    The Annualized Total Return Roller Coaster

    Here's an interesting set of charts that will especially resonate with those of us who follow economic and market cycles.

    Imagine that ten years ago you invested $10,000 in the S&P 500. How much would it be worth today, adjusted for inflation with dividends reinvested? The purchasing power of your investment has grown to $10,533.11, an annualized real return of a rather disappointing 0.51%.

    Had I posed the same question in March 2009, the answer would have been a depressing $5,518.55. The -5.93% real return would have cut the purchasing power of your initial investment virtually in half.

    Now let's imagine that we time-travel back to September 2000 and pose the same question. Your ten-year inflation-adjusted gain would have been 396% for an annualized real return of 16.13%. As the chart illustrates, investment performance with a 10-year timeline has been a real roller coaster as far back as we have data.

    If we extend our investment horizon to 20 years, the roller coaster is less volatile with higher lows and lower highs.

    The volatility decreases further with a 30-year timeline. But even for that three-decade investment, the annualized returns since the 1901 have ranged from less than 2% to over 11%.

    As these charts illustrate, and as many households have discovered over the past few years, investing in equities carries risk. Households approaching retirement should understand this risk and make rational decisions about diversification. They should also consider fixed income alternatives for that part of the nest egg that will pay non-discretionary expenses not covered by Social Security and pensions.

    China’s “Rare Earths” Exports Collapse, World Prices Soar

    Let’s think back to September 2010. Japan confronted China at sea in a dispute over fishing rights. The Japanese arrested a Chinese fishing boat captain. The Chinese soon imposed an embargo on rare earths exports to Japan.

    Suddenly, rare earths – a relatively obscure set of industrial minerals, oxides and metals – became the stuff of high international attention and intrigue. It became common knowledge that China controls about 97% of the world’s rare earths output. Overnight, the dire industrial and political implications of that geological monopoly became apparent.

    Investors were – and are – right to be interested in this situation. Just last week, we learned that the value of China’s rare earths exports has soared almost nine-fold, year on year. That is, a tonne (i.e., a metric ton) of Chinese rare earths – a weighted composite of 17 different materials – currently rings the cash register for just over $109,000. This is up dramatically since July 2010, when each tonne averaged buyers a mere $14,405.

    In other words, China is raking it in. In fact, the prices of rare earths out of China have averaged about a $10,000 increase per tonne per month over the past year!

    It gets worse for non-Chinese users. In February 2011 China reportedly exported a total of 750 tonnes of rare earths to a global array of buyers. This was slightly more than the 647 tonnes China shipped in January. Yet in just this one month, the average price for a tonne of rare earths leapt ahead by $34,000, according to a calculation by Reuters News Service based on data from China’s customs office.

    The rapid increase in price is due to the Chinese government’s successful effort to restrict and reduce the volume of rare earths exports. Adding to the confusion, China has also changed the way it reports rare earths exports. This has artificially boosted the volume figures by including products made from rare earth metals in the total.

    Could things get worse for Western buyers and users? Well, yes. Also last week, we learned that China might soon start importing some of the rare earths that its economy needs but doesn’t produce in sufficient quantity.

    According to Liu Junhua, the deputy secretary for China’s Baotou Rare Earth High-Tech Industrial Development Zone Committee, “China may eventually need to import [heavy rare earths] materials.” According to Mr. Liu, speaking at a recent conference, there’s a “strong possibility of [China] importing heavy rare earths” in the next three-four years.

    So here’s the scenario: Chinese export volumes are down. World prices are rising, and fast. And China may soon be importing the heavy rare earths for its own industrial needs.

    Let’s review what this all means for investors…

    The share prices for rare earths companies began to soar last fall. After the Japan-China dust-up in September, rare earths companies quickly became stock market darlings.

    Many of the rare earths stocks I recommended to the subscribers of Energy & Scarcity Investor doubled in fairly short order. I suggested taking profits on two of those stocks, but still advocated long-term investments on selected stocks in this sector.

    Looking back toward the end of 2010, pretty much any company with a “rare earths” tag line was a strong performer in the stock market. The investment community threw big money at a large stable of rare earths investment opportunities. But times have changed.

    In the past six weeks or so, in the face of tight demand and fast-rising prices, investors have looked at the rare earths sector with even sharper, more discerning eyes. The rationale is twofold.

    First, only a few non-Chinese companies will achieve output – and begin to generate cash flow – within the next three years. And second, only a small handful of companies will survive in the long-term race to supply the world with rare earths over the next decade or so.

    One company I recommended should have a new mine up and running by the end of this year. Another company, one that I consider an excellent speculation, is modernizing a rare earths facility in Russia.

    Meanwhile, there’s Molycorp, a company that is reconstructing its mine, mill and other facilities at Mountain Pass, Calif. It’s a major effort, with a sticker price in the vicinity of $500 million. The announced time scale is in the 24-month range. My concern about Molycorp is that the California project involves building a brand-new plant, with new equipment and bringing in a newly hired work force that’s still in training. Anything could go wrong and cause delays. And considering that it’s happening in mining-unfriendly California? I’m sure you get my point.

    The larger point is the rare earths story is not going away. It is getting bigger every day and is sure to provide some outstanding opportunities for vigilant investors.


    Byron King

    Marc Faber - Mr. Bernanke is a Murderer of the Middle Class

    Today King World News interviewed Barron’s roundtable member Dr. Marc Faber. When asked to compare the 70‘s cycle to the current one Faber responded, “Well I think we have had in the 70’s rapidly escalating commodity prices, and in some cases they went up much more than what we’ve seen so far in the last ten years. Of course the financial position of the US is much worse than what we had in the 70’s. In the 70’s, total credit as a percent of the economy was just at 140%, we’re now at 379% and we have the unfunded liabilities which we didn’t have at that time. So I would say the financial position of the US has continuously worsened over the last 30 years.”

    When asked about the proposed $5.8 trillion in cuts to the US budget Faber stated, “Well I think what they are discussing in terms of cutting the budget is far too little, and the problem is that you can’t actually cut a lot of expenditures because they have to be met. In other words social security, medicare, medicaid, that you can’t really cut. Also the military budget is really difficult to cut because the military complex in the Unites States, the lobbyists are very powerful.”

    When asked about silver specifically Faber remarked, “Well my friend Eric Sprott he maintains that there is a genuine shortage of silver and that may be the case so silver may still move up...Now with the loss of purchasing power of the dollar and other currencies people are concerned if they have say a million or a billion dollars that the value of these dollars will one day be next to nothing.

    So they have to invest in something and so they look for real estate, they look for equities and of course they come to realize slowly, I have to say very slowly that gold and silver are not commodities in the sense of industrial commodities, but that they are currencies. Precious metals are basically currencies that are honest because you can’t increase the supply indefinitely. You can’t have QE2, QE3, QE4 in the gold market.

    ...If you print money everything will go up...and now the money printing doesn’t go into housing because we have an oversupply of housing, but it goes into equities and for Mr. Bernanke unfortunately into commodities. And this is lifting the cost of living of the median household, of the typical household in the US...Mr. Bernanke is a murderer, he’s a murderer of the middle class and the working class.”

    The destruction of the middle class will be a huge issue going forward for the United States. As the chasm between the rich and the poor widens, in all likelihood we will see civil unrest in the US. I suspect in the end Faber will be right, Bernanke will continue to be a murderer of the middle class. He will be the “great destroyer” of the standard of living for most Americans.

    The KWN interview with Marc Faber is available now CLICK HERE to listen.


    After a brief dip in recent weeks, sentiment has shot back towards its highs. Although I’ve had trouble finding any definitive connections between QE2 and real economic growth, there is one certain connection – QE2 is having an enormous impact on investor psychology. Since QE2 began we have had a persistent optimism in the markets. This is clear in both of the major sentiment surveys I track where sentiment has remained at a permanently “extreme” range throughout QE2.

    This week’s readings take us back towards this extreme level. Charles Rotblut of AAII elaborated on the AAII survey:

    “Bullish sentiment, expectations that stock prices will rise over the next six months, improved 1.8 percentage points to 43.6% in the latest AAII Sentiment Survey. This was the third consecutive weekly increase and it puts optimism at a seven-week high. The historical average is 39%.Neutral sentiment, expectations that stock prices will be essentially unchanged over the next six months, remained essentially unchanged for the second consecutive week at 27.6%. The historical average is 31%.

    Bearish sentiment, expectations that stock prices will fall over the next six months, fell 2.2 percentage points to 28.8%. This was the third consecutive decline in pessimism, which is now at a seven-week low. The historical average is 30%.”

    The Investor’s Intelligence survey is showing an even more extreme trend. This week’s reading surged 5.7% to 57.3%. Investors are extremely bullish.

    Thus far, this optimism has only fueled equities throughout QE2. Although QE2 is unlikely to have much of an impact on the fundamental economy we have to begin wondering what will happen when this persistent confidence high gets sucked out of the market?

    Robert Winslow: Potash Stocks Grow with Agriculture Boom

    The Energy Report: We know that a growing population is a long-term driver of fertilizer, but what has driven the potash market so dramatically higher over the last six months?

    Robert Winslow: Well, it's interesting and it's pretty simple. The key driver for all these Ag equities is rising grain prices—whether it's potash, phosphate, agricultural equipment manufacturers or any companies in the Ag space. These equities generally benefit when grain prices are rising.

    It's a function of farm income—the grain complex drives farm income, which drives farm expenditures. We called the bottom of the grains back in July 2010. As the grains have come off the bottom, the obvious expectation of farmers is that they're going to make more money and they feel a little bit better. The result is that they'll spend a little bit more money perhaps on seed, fertilizer, tractors, storage bins—you name it. So, it's all driven by what the grains do.

    TER: The potash stocks have had a good run over the last six months.

    RW: I would actually suggest it's more like the last three or four months. Even though the grains really bottomed last summer, it took some time for the fertilizer stocks to move. When I say "the fertilizer stocks," I'm talking about the smaller-cap equities primarily; that's our focus area. And I think one of the big drivers of the move in the equities was that rising grain and food prices got picked up by the media. If you go back to December 2010, we started to see reports in leading magazines, newspapers and on TV suggesting that, based on UN data, food prices had gone back to 2008 levels. Once that kind of news gets picked up on the front page of newspapers, it does tend to drive investor interest.

    TER: When the media picks up on it, retail investors come in. Is that what you're saying?

    RW: Well, I think it does bring retail investors in, but not exclusively. There are also a lot of institutional investors—sophisticated investors—who are looking for the next cycle and, indeed, Ag equities are cyclical. You always want to be looking for cyclicals that are at or near a bottom or coming off a bottom; that's when you buy them. Then you want to sell them when they get toward the top. Ag was a sector wherein the fundamentals—the grain prices and supply/demand situation—were teeing up nicely and coming off a bottom, but the equities weren't moving.

    TER: Does potash lag grains or other Ag crops?

    RW: We've run correlations between our coverage universe of equities and the grains, and the short answer is no. I cover 15 equities in the Ag sector and when you run a correlation between those equities and the three major grains and oil seeds (i.e., corn, wheat and soybeans), it's almost a 90% correlation. So, really it's difficult to find a leader or laggard in there. They basically move together and are driven by the expectation of what the farmers will do. When I say "grains" are going up and farmers will spend more money, they won't actually spend the money until they've got it in their coveralls, so to speak; but, the investment community recognizes farmer enthusiasm and improving expectations. So, the grains and the equities move very closely to each other.

    TER: The potash producers now have pricing power. But is this across the board to all the fertilizers—phosphates and others?

    RW: Generally speaking, yes. Again, it's a function of higher grain prices. It's interesting; we saw this back in '08 when corn approached $8 a bushel. A lot of the major fertilizer companies were talking about $1,000/ton potash; in fact, some transactions were done at spot prices, which were around $1,000. There wasn't a lot of volume there, so, arguably, it wasn't a good indicator of price.

    Depending on what part of the world you're in, potash pricing is $400–$500 per ton. And there's still some flexibility for those prices to stay there or go a little higher because it's not becoming a burden to the farmer. I would suggest that there's room to go on potash pricing still. I would say the same with phosphate because we've got pretty tight supply and demand dynamics for those fertilizers. But, I don't think that we're talking $1,000 potash again anytime soon.

    TER: With the strength potash stocks have demonstrated, do you expect them to take a break?

    RW: Yes, a lot of them already have taken a break. Again, coming back to the grain prices, we feel there is more risk to the downside than the upside. The grains have come off a little bit and the equities accordingly. So, yeah these sorts of breathers are healthy. I think it's important to recognize, however, that when we talk about risk to the downside versus upside, we are talking about the current cycle; we still have a bullish view for a secular uptrend in Ag commodities.

    TER: Where can investors get an advantage?

    RW: Well, interestingly enough, Allana Potash (TSX.V:AAA) put out a press release recently and announced another strategic investor. It's the International Finance Corporation (IFC), which is a member of the World Bank. IFC is putting $10 million into Allana; obviously, the company has done due diligence and likes what it sees there. Allana is developing the Dallol Potash project in Ethiopia, and we're quite keen on it because it's got some interesting advantages versus some of the other junior potash plays. Apparently, IFC has done its homework and has a view similar to ours.

    TER: What does IFC's investment mean for the company?

    RW: It's an interesting development for Allana because it provides credibility. In other words, it's not just an analyst saying it's a good project—it's a sophisticated investor saying it's a good project. And, it also helps mitigate finance risk. All of these junior fertilizer companies have to raise a tremendous amount of capital; for example, we believe Allana has to raise somewhere in the neighborhood of $800–$900 million (all in) for the total project. So, you want to be able to secure financing over time to make sure that it gets built.

    When someone like the IFC steps up and puts $10 million of equity into a company, it's got some skin in the game and, arguably, will be around when it's time to raise more equity and/or debt capital. So, we think a development like this is a positive and, on the back of that development, raised our target on Allana nominally to $2.25 from $2.15. But, we do have a strong buy rating on that stock. Frankly, it's one of those stocks that could double or triple over the next two or three years as this theme plays out.

    TER: Could that IFC investment have any negative implications, in terms of a potential takeover?

    RW: I would say no. I think that, at the end of the day, IFC wants to help facilitate this project to help stimulate the Ethiopian economy. And if the company is taken out, it definitely would be by a bigger and better-capitalized company that should be able to ensure the project gets built. I think it'd be a win/win situation if there was to be a takeout.

    TER: Your $2.25 target price has an implied +40% upside from here.

    RW: Yes. It doesn't seem all that compelling but we had a $1.00 target on AAA when it was $0.40. This company is one that's gone very far, very fast and was due for a pullback.

    TER: In a note, you compared Allana to the German fertilizer company K+S Aktiengesellschaft 's (Fkft:SDFG.F) acquisition of Potash One Inc. for CAD$434, I believe.

    RW: Right. The interesting thing was that the Potash One multiple was estimated at 0.45 of the enterprise value (EV) to net asset value (NAV). But that was before grain and food prices had risen so much. It was closer to the bottom of the current cycle. As I said, these stocks are cyclical and I feel that we're closer to the top of the current upcycle here.

    TER: Sounds like that $10 million investment from IFC really derisked this play.

    RW: It helps for sure; it definitely helps. There's a long way to go yet—a lot of capital to be raised; but when you've got a partner like that working with you, that's impressive. That's well done.

    TER: Allana's market cap is in the $265M range, which is high enough for mutual funds to buy the stock. You recommended AAA when it was a penny stock. Congratulations on that call, by the way.

    RW: Thank you.

    TER: You've seen Allana go from a level at which mutual funds couldn't buy it to where they can now. Is that where the next leg up is coming from—more institutional investors coming in?

    RW: Well, that's a part of it; but I think the biggest part will come over time as the company meets and fulfills its milestones. Then, as you pointed out, when the market cap gets through certain thresholds, you can bring a new list of investors into the mix. A number that's often used here in Canada that many fund managers look at is CAD$100M market cap. When a stock gets through that level, they can start to look at it.

    TER: You rate Allana a Strong Buy. Are there any other strong plays that you can mention?

    RW: Yes. Another one that we follow is IC Potash Corp. (TSX.V:ICP; OTCQX:ICPTF). It's looking to develop an operation to produce sulfate of potash (SOP) from polyhalite in New Mexico in the U.S. Now, the company is working to confirm that the polyhalite-to-SOP conversion process can be done. About 50 years ago, Potash Company of America, which was acquired by PotashCorp (TSX:POT; NYSE:POT) in 1993, did some work on converting polyhalite to SOP that showed it could be done. Now, IC Potash is going back and duplicating those tests and getting favorable results.

    It's early days yet and some pilot test work needs to be done, but it looks like the conversion operation will work—making it the lowest-cost (or among the lowest) SOP production in the world. It could be in the bottom 10% on the cost curve, and that's one of the reasons we like that project. Anytime a company can get costs that low, I'm intrigued; so, that stock is coming along nicely. It, too, has come off in the last three or four weeks and is not immune to the selloff in the space—but, that's one stock we like a lot.

    TER: I see that IC Potash raised $20M in equity, recently. Is that enough to derisk the project?

    RW: Well, it goes a fair way to derisking it. Again, the company will likely be looking at spending $600–$700 million. We estimate this recent capital raise will get IC Potash through its prefeasibility study (PFS) and into 2012. So, the company has at least a year's worth of capital to complete the milestones it plans. Then, it would have to come back to market at some point.

    TER: You rate ICP a strong buy with an implied 75% upside from here.

    RW: That's right, $2.50 target. We use 12-month targets.

    TER: Is there a phosphate opportunity that you like?

    RW: MBAC Fertilizer Corp. (TSX:MBC) is developing a phosphate project in Brazil. We like this one because, from a transport-cost perspective, it's advantaged logistically. Brazil is a large Ag-based, or Ag-centric, economy and about 25% of its GDP is driven by this sector. The country has a tremendous amount of arable land that can be expanded to help feed the world and also has an enormous amount of fresh water. So, it's got the fresh water and the land. We think agriculture will drive that economy for years and years to come. So, that's the macro view and the overlay on why we like Brazil.

    Now keeping that growth in mind, consider that Brazil imports half of its phosphate and 90% of its potash. So, the country is beholden to imports for its fertilizer even though it's an Ag-centric economy. MBAC's phosphate deposit in the Cerrado is next door to the growing region that's like the Brazilian breadbasket. With this project, the company is looking at mining phosphate ore and converting it to single super phosphate (SSP)—a type of phosphate fertilizer that has sulfur in it. In phase one, MBAC is looking to bring on 500,000 tons of production by summer 2012; so, we're less than 18 months away from that. There also are prospects for phases two and three (in other words, not just 500,000 tons), but it could go up to 1.5 million tons (Mt.) of single super phosphate or other phosphate fertilizers over the next five years or so.

    We estimate MBAC has a transportation advantage in the neighborhood of $60–$90/ton because, right now, the brunt of the phosphate rock that comes into Brazil comes from Morocco. Once it's on vessel in Morocco, it has to cross the ocean, land on the coast of Brazil and be offloaded and import duties will be paid. After the material is put on a truck or rail, it must be transported all the way up to the Cerrado. That whole transportation-and-logistics situation costs a tremendous amount. MBAC can eliminate that cost because it has this deposit right in the Cerrado. So, we think that advantage is competitive and sustainable. We expect MBAC to drive significant economics with this project. We're looking at about $65 million of EBITDA for phase one, and we believe that can grow to north of $200M of EBITDA with phases two and three.

    TER: With that transportation advantage, it wouldn't take a lot of capital to double.

    RW: Well that's the other thing. Unlike a lot of these junior stocks we talk about, the financing (on phase one) is largely done. MBAC recently raised a little over $40 million of equity and now has about $90 million of cash on the balance sheet. Now, the company's securing debt facilities with IFC and the local banks in Brazil. So, we're looking at the company just dotting the "Is" and crossing the "Ts" on these agreements. It has a bit of due diligence to do but it's very close to being done. We've got a $6 target on the stock. It's trading at around $3 now. We believe MBC could be a $15–$20 stock inside four or five years.

    TER: I've enjoyed meeting with you. Thank you for your time.

    RW: Thanks very much.

    Ryan: Debt On Track To Hit 800 Percent Of GDP

    ( – House Budget Chairman Congressman Paul Ryan (R-Wis.) said President Barack Obama’s budget strategy is to “do nothing, punt, duck, kick the can down the road” while the debt remains on track to eventually hit 800 percent of GDP and the CBO is saying it “can’t conceive of any way” that the economy can continue past 2037 given its current trajectory.

    Ryan also said that the House Republicans’ FY2012 budget, which he unveiled yesterday, would save Medicare and help the United States avoid a debt crisis.

    “It all comes down to this: Either you fix this problem now where we, you can guarantee people who’ve already organized their lives around these programs get what they have coming to them, or you pick the president’s path, which is do nothing, punt, duck, kick the can down the road, and then we have a debt crisis and then its pain for everybody,” said Ryan.

    “Then, you do start cutting seniors,” he said in a speech at the American Enterprise Institute (AEI) in Washington, D.C. on Tuesday. “So, the question here is not if we reform Medicare. The question is when and how we reform Medicare and by reforming Medicare now, you save Medicare.” Ryan said during

    He continued, “So the question is, do we save these programs now by engaging in budget reform that preempts a debt crisis that gets this situation under control and gets this economy growing or do we worry about politics, do we worry about the next election and then by doing so, kick the can down the road, only to wake one day and see a real problem where you have to do indiscriminate cuts to everybody including senior citizens? We don’t want to have European austerity in this country, which is a debt-crisis-fueled cut to current seniors, tax increases on the current economy to slow us down.”

    Ryan’s proposal, which cuts $5.8 trillion in government spending over the next decade, would provide Medicare beneficiaries with subsidies to purchase private insurance starting in 2022. The proposal would also end taxpayer support of Fannie Mae and Freddie Mac and provide no funding for the implementation of the health care reform law passed by Congress last March.

    “We’re on a debt crisis path. We are on a path where the government goes from 20 percent of GDP, to 40 percent then 60 percent of GDP. We’re on a path where our debt goes from about 68 percent of GDP to 800 percent of GDP over the three-generation window,” Ryan said.

    “I asked CBO to run the model going out and they told me that their computer simulation crashes in 2037 because CBO can’t conceive of any way in which the economy can continue past the year 2037 because of debt burdens,” said Ryan.

    “So, we have to go out and give the country a choice,” he said. “We know the path the president’s put the country on. It’s a path that I fundamentally believe transforms this country into something it was never designed to be – into a cradle-to-grave social welfare state and economic stagnation.”

    “We are offering a country that is true to this country’s founding principles that is prosperous, that is pro-growth, that lives within its means, that is an opportunity society with a sound, resilable safety net,” said Ryan.

    10 Day Moving Average Rule Hits as S&P 500 Goes through 6th Day of Consolidation

    The market continues to show tremendous resiliency and an inability to pull back. This is the 6th day of a tight trading range, and that has allowed the 10 day (exponential) moving average to catch up to the freight train that has been the market. Outside of exogenous global events, the S&P 500 has essentially held the 10 to 13 day moving average range the entire rally.

    Speaking of exogenous events, it is remarkable how global bailouts are now taken in stride. Nearly a year ago the Greece sovereign crisis led to a worldwide selloff - some of the heaviest selling since the rally began in March 2009. Then in November 2010, we had a more modest selloff of about 6-7% due to the Irish sovereign debt crisis.

    The current Portugal sovereign debt crisis, in which a formal request to be bailed out was announced in the past 24 hours? Who cares! Business as usual in the bailout nation globe. Of course part of this has to do with the ESFS (a sort of TARP for European countries), but the market has become numb to things that would be unthinkable just 3 years ago.

    Vibrant to Vacant: Mall Vacancies Highest in 11 Years; Online Retail Sales Hit 12%

    Online retail sales keep climbing, big box retailers keep wondering what to do with all their space, and small stores struggle to survive at all. As a result of that nasty brew, Malls Face Surge in Vacancies.

    Mall vacancies hit their highest level in at least 11 years in the first quarter, new figures from real-estate research company Reis Inc. showed. In the top 80 U.S. markets, the average vacancy rate was 9.1%, up from 8.7%.

    The outlook is especially bad for strip malls and other neighborhood shopping centers. Their vacancy rate is expected to top 11.1% later this year, up from 10.9%, Reis predicts. That would be the highest level since 1990.

    In the Denver suburb of Westminster, Colo., city officials are negotiating to buy and raze the 34-year-old Westminster Mall and redevelop it into offices, homes and stores. The 1.2-million-square-foot mall, once home to a Macy's, Trail Dust Steak House and Mervyn's, has seen its sales-tax generation plummet in recent years, to $1.5 million last year from $8.5 million in 2000, city officials say.

    The mall went "from a place that was once vibrant to something that is now virtually vacant."
    Shopping Center Economic Model

    In 2005, the mall-vacancy rate hit a low of 5.1%. For strip centers the boom-time low vacancy rate was 6.7% that same year.

    On April 18, 2008 I wrote Shopping Center Economic Model Is History
    Lease rates are going to sink, vacancies are going to soar, and the oncoming supply of mall space with no tenants is going to bankrupt many regional banks that funded such construction. The shopping center economic model will soon be history.
    Bank Failures

    Inquiring minds may be interested in a recap of Bank failures in the United States 2008–2011

    2008: 25
    2009: 140
    2010: 157
    2011: 26

    Only So Many Shoppers

    A couple weeks ago I was contacted by a reporter in Las Vegas about a new mall going up in the city. I told him the obvious: There are only so many shoppers.

    What good can a new mall do? During construction it will provide a few jobs. Then what? Then instead of shopping at the old mall people start shopping at the new mall. No one buys any more stuff.

    Shopping Center Dynamics

    Ironically, is quite common for city councils to give huge tax breaks to new businesses that "create jobs".

    Mayors love ribbon-cutting events like mall openings. Then a few years down the road if not sooner, everyone wonders where the jobs are and why expected sales tax revenues did not materialize.

    There is no need to wonder. The answer should be easy to spot in all the vacant strip-malls and closed stores elsewhere.

    To be sure, there are some city revivals, but those come at the expense of shoppers staying local rather than driving to the nearest town . The reverse also happens. People travel to the new mall in the neighboring city rather than shop local.

    This dynamic ensures that malls and strip-malls go up everywhere until there is a crash, which is precisely where we are now.

    Online Sales Compound the Mall Problem

    A few years back online sales were about 6% of total sales. Online sales hit 12% this past Christmas. State and local governments are more than a bit upset about the lost sales tax revenue.

    Malls and big box retailers are upset too. Everyone hates Amazon, except Amazon customers.

    Big box retailers have a glut of space and many are starting to shrink the number of items they carry. However, every item they do not carry that someone wants to buy, is another item someone will decide to buy online.

    Yet, every online purchase is one less trip and fewer miles on the car. Thus online shopping also impacts gasoline sales, gasoline tax collection, and car maintenance.


    The population is getting older. In advanced years, much of what people buy is health- or food-related, not gadget-related or travel-related.

    A certain set of people never became comfortable with the internet and internet shopping. Younger generations have no aversion to buying online or not buying at all.

    Those fresh out of college are deep in debt and struggle to pay that debt off.

    As boomers head into retirement many are scared half to death about insufficient savings. Their peak shopping years are now well behind them.

    One bright spot lately has been a revival in luxury items. However, that has largely been a result of the stock market revival. Should there be a sustained relapse in the stock market, luxury sales will take another dive as well.

    In light of the above, I see no sustainable revival in the shopping center economic model for years to come.

    Extreme Leverage, Extreme Instability, Extreme Risk

    We tend to speak of leverage in financial terms, but as frequent contributor Harun I. notes, leverage and thus risk is ever-present in everything from oil to technology.

    Some call it complexity or hyper-complexity, to me it's all about leverage. The greater the leverage the greater the instability. And developed societies are too heavily leveraged in technology (knowledge), finance (credit) and energy. Remember, your prediction of a 4% failure in housing causing a complete collapse in that sector was dead on. But that 4%, which globally represented much less, collapsed the entire global banking system.

    Technologically, there are too few people holding the knowledge to systems that are now considered vital; the same can be said of the monetary systems (the Fed insists on black box operations in conducting monetary matters). Crude oil and all its derivatives from which we get fertilizer to Tupperware to space shuttles: the extend to which we are leveraged via oil is incalculable.

    Thank you, Harun. The greater the leverage, the greater the inherent instability and thus the greater the risk.

    We tend to think of crude oil as the feedstock for gasoline and jet fuel, but it's also the feedstock for agriculture (fertilizers and transport), plastics (a significant percentage of industrial products) and ultimately everything else via transport.

    Conventional economists are constantly cooing that oil accounts for a smaller percentage of the U.S. economy that it did in the 1970s; but does that mean that the economy is any less vulnerable to supply disruptions? The concept of leverage helps us understand how removing $650 billion in crude oil from the U.S. economy (18 million barrels a day X 365 days = 6.5 billion barrels X $100 per barrel = $650 billion) is not just a simple subtraction of 4.5% of total GDP ($14.7 trillion): it would trigger the implosion of the entire U.S. economy.

    That's leverage.

    How many people truly understand the precise mechanics of last year's "flash crash"? Does anyone really understand what interactions of high-frequency trading computers led to a stick-slip/criticality/crash? How dependent is the system on their expertise?

    How many people operate the Federal Reserve's many opaque interventions in the market? What sort of daisy-chain ties the Fed's moves to other central banks? What happens if that web of intervention breaks down or seizes up?

    The conventional spectrum of punditry and economists dismissed the idea that U.S. housing was a highly leveraged sandpile waiting for a stick-slip event. But the leverage piled on leverage was self-evident: the consumer borrowing (home equity lines of credit, refinancing, etc.) that fueled much of the "growth" in spending was leveraged off the housing bubble, which also leveraged rising demand for lumber, granite countertops, high-end refrigerators, etc., and a stupendous mountain of derivatives, credit default swaps, mortgage-backed securities and other financial instruments which leveraged up Wall Street's profits and valuations.

    The entire sandpile collapsed once its riskiest grains--the designed-to-default subprime option-ARMs and no-document liar loans--succumbed to the inevitable.

    Some observers insist there cannot be another recession because there is always 7-10 years between recessions. This is just like saying the U.S. could brush off the removal of 18 million barrels of crude oil a day because the oil only represents 4.5% of the GDP, and surely the economy has declined 4.5% in the past without any permanent damage.

    Except that 4.5% is highly leveraged, and the system is totally dependent on it. That leverage creates a fundamentally unstable system, which is highly vulnerable to disruptions which quickly cascade in a series of inter-connected, self-reinforcing feedback loops--just like "flash crashes" and markets which suddenly have no bid.

    The recovery is self-sustaining, technology will save us, the U.S. economy is resilient, don't fight the Fed, the stock market is on a permanently high plateau thanks to the Bernanke Put, blah blah blah. Check back in in 15 months and let's see who's right: the "The recovery is self-sustaining, stocks are on a permanently high plateau" crowd or those of us looking at the leverage being piled on leverage.

    Natural gas drops; Oil jumps above $110

    While oil continues to rise to new highs, the price of natural gas dropped 2 percent Thursday and has remained relatively flat since the recession.

    Traders say the reason is simple: oil is traded internationally and is heavily influenced by demand from China and other emerging economies. The U.S. is awash in natural gas but lacks the infrastructure to export it, and a recent boom in production has kept prices in check.

    The contrast between the two was clear on Thursday. Natural gas plunged after the government said supplies dropped less than expected. It gave up 8.9 cents to settle at $4.057 per 1,000 cubic feet. Meanwhile, oil surged to $110.30 per barrel, reaching a new 30-month high, even though U.S. oil supplies have been increasing. They grew by 2 million barrels last week, according to the Energy Department.

    Oil and natural gas seemed to be in lockstep in 2008, when prices for both spiked. "But there's really no relationship between them anymore," analyst Jim Ritterbusch said. The average price for natural gas dropped 5 percent last month, when compared with March of last year. Oil, on the other hand, surged 27 percent in the same period.

    The emergence of shale gas drilling in the U.S. likely will keep natural gas storage facilities filled with a hefty surplus, Ritterbusch said. New technologies have helped drillers tap vast underground reserves that are estimated to be large enough to supply the U.S. for more than a century.

    Shale gas production has soared more than 12-fold in the last decade, according to the Energy Information Administration.

    Even after an especially chilly winter, when homes and businesses cranked up the heat, natural gas supplies haven't dropped as much as expected.

    The EIA reported that natural gas stocks fell by 45 billion cubic feet last week. Analysts expected an even bigger drop of between 49 to 53 billion cubic feet. The report was another sign that "good demand is not even putting a dent in supply," analyst and trader Stephen Schork said.

    Meanwhile, gasoline pump prices are still rising and setting records for this time of year. The national average increased nearly 2 cents on Thursday to $3.725 per gallon, according to AAA, Wright Express and Oil Price Information Service. A gallon of regular increased by 20.8 cents in the last month and is 88.1 cents higher than last year.

    Americans are paying $247 million more per day at the pump than they were at the start of the year.

    In other Nymex contracts for May delivery, heating oil lost 1.48 cents to settle at $3.2060 per gallon and gasoline futures lost 0.64 cents to settle at $3.1865 per gallon.

    In London, Brent crude gained 33 cents to settle at $122.26 per barrel on the ICE Futures exchange.