news

8th June 2009

This issue: Surrealism and Orwellian propaganda

means panic about inflation
Surrealism and Orwellian
propaganda means panic The rise in long-term interest rates in the US and UK and whether
about inflation it signifies impending inflation or recovery, both at the same time,
or whether it kills off any chance of recovery via higher mortgage
Stock market standoff rates, continues to hold centre stage:
- Coppock versus Martin
Armstrong (here) US 10-yr Treasury yield

Source: barchart.com

When I step back from events in the financial markets, the whole
scene looks increasingly surreal. I’m reminded again of my
analogy of the journey up the Nung River in the film Apocalypse
Now.

Back in 2006, when I first grasped what was unfolding,

subsequent events took on an almost slow motion nature. It feels
the same again – that we are heading towards severe currency
and economic crises in both the US and UK. The only question is
whether the authorities can induce one last upturn before it goes
very, very wrong? Last week I quoted the Cara Trading team
in the Bahamas saying “Do you feel like a frog dropped in the
lukewarm water as the heat is slowly turned up?”. This week, I’m
reminded of Colonel Kurtz (Marlon Brando) from the film:

Paul Mylchreest
paul@thunderroadreport.com
 “I watched a snail crawl along the edge of a straight razor. That’s my dream. That’s my nightmare. Crawling,
slithering, along the edge of a straight razor and SURVIVING”

We can but hope. There are people like the Credit Bubble Bulletin’s Doug Noland who articulate beautifully
the shameful mismanagement of events:

“the responsibility lies more generally with a deeply flawed monetary policy regime – a regime hopelessly
locked in interest-rate manipulation and inflationism…At some point the inflationists should accept the
reality that they are a big part of the problem – and not the solution.  Is that what the bond market is
beginning to tell us?

Which brought to mind Apocalypse Now again and Captain Willard (Martin Sheen):

“The war was being run by a bunch of four star clowns who were gonna end up giving the whole circus
away.”

But back to Doug Noland:

“We’re witnessing the same analytical errors today that were made in the post-tech bubble analysis: the
willingness to inflate an even greater bubble for the cause of mitigating the pain from the so-called
deflationary risks associated with a bursting of THE bubble. And with each reflation comes a heightened
governmental role in both the markets and real economy – to the point where Washington is essentially
backstopping the financial and economic systems.” 

Eventually, the purchasing power of the dollar and Sterling will be overwhelmed but we’ve got some way
to go yet - into what aficionados will recognise as the heart of darkness.

“I’m going 70 clicks above the Do Lung bridge”

“That’s Cambodia Captain”

“That’s classified”

Talking of surreal, I almost have to pinch myself to accept the shameful fact that two key protagonists in
charge of the stewardship of the US and UK economies are still turning up for work. In the US, we have a
tax evader, Tim Geithner, as Secretary of the Treasury who was voted in by the Senate Finance Committee
even after his transgressions came to light. In the UK, we have a Chancellor of the Exchequer, Alastair
Darling, who claimed expenses on two second homes at the same time in contravention of parliamentary
rules. Gordon Brown wanted to replace Darling with his ally, Ed Balls, but conventional wisdom has it that
our Prime Minister is in such a weakened position he could not even risk sacking a Chancellor who had
“fiddled” his expenses and was refusing to resign. What’s happened to us?

Last week, Geithner was even humiliated by a bunch of Chinese students as Reuters reported:

“Chinese assets are very safe,’ Geithner said in response to a question after a speech at Peking University,
where he studied Chinese as a student in the 1980s. His answer drew loud laughter from his student
audience, reflecting scepticism in China”

What I found interesting was not the entirely justified reaction of the Chinese students, but how this incident
was reported, or rather, not reported in the US. GATA supporter, Chuck Cohen, commented from New York:

“The coverage of the Geithner speech before the students was very strange. It was reported in all of
the non-mainstream media that they laughed at his comments about the dollar. But I couldn’t find any
reference to it in the Times, the Journal and Bloomberg, so I thought that perhaps it was made up. But I
just found this from the London Times that verifies that it happened as reported. My point is that it was
obviously intentional that none of the mainstream financial media reported it.”

© Thunder Road Report - 8 June 2009 2

 When Geithner was wrapping up his trip to China, CNBC’s Steve Liesman was granted an exclusive interview
with him. Sadly, but not surprisingly, he didn’t question Geithner on his very newsworthy humiliation at
Peking University. Presumably Liesman had adopted the compromised role of the “embedded journalist”
first created with the 2003 invasion of Iraq. Wikipedia explains the concept:

“When asked why the military decided to embed journalists with the troops, Lt. Col. Rick Long of the U.S.
Marine Corps replied, ‘Frankly, our job is to win the war. Part of that is information warfare. So we are going
to attempt to dominate the information environment.”

Despite this, Liesman still pressed Geithner on the US printing money to buy its own debt, which is when
the Orwellian propaganda kicked in. Liesman asked:

“Treasury is issuing over time, and not so much time, trillions of dollars of debt. The Fed is buying US$300bn
of Treasury’s debt. Why is this not the dreaded concept of monetising the debt which so many economists
have warned about?”

Geithner replied:

There’s no risk of that in the United States. We have a strong because (sic), again, we have a strong
independent central bank whose obligation under the law is not just to achieve maximum sustainable
growth but to keep inflation low and stable over time…”

“You’re saying that buying US$300bn of debt is not monetisation?”

“Absolutely not and again, err, the no conflict (sic) between the Fed’s responsibilities for financial stability,
the measures they’ve taken to help make sure there’s liquidity for markets. We’re easing this process of
adjustment in the financial system and their long term obligation to help keep inflation low and stable and
I’m completely confident in their ability to do that.”

There’s only one CNBC (“Financial Entertainment TV”) journalist who I have time for and that’s Rick Santelli
who has the rare skill these days of calling a spade a spade.

“Well, you know the first part of that question was economists are worried about quantitative easing - are
we monetizing? And his answer was no, we have a strong independent central bank. Now the latter may be
true but it certainly isn’t an answer to the question and I put forth, and I’d like feedback everybody - that
quantitative easing can’t exist without the monetization process. We issue debt; we print the money to
buy it. That is monetizing. I can’t believe that was his answer…He’s not telling the truth and if he doesn’t
understand it, that’s more scary. And if he understands it, he’s lying to the American people.”

The day after the Geithner interview, Ben Bernanke was on Capitol Hill in front of the House Budget
Committee. The ranking Republican, Paul D. Ryan of Wisconsin, challenged Bernanke on monetisation
arguing:

“The Treasury is issuing debt and the central bank is buying it. It gives the alarming impression that the
U.S. one day might begin to meet its financial obligations by simply printing money.”

Bernanke’s response was:

“The Federal Reserve will not monetize the debt. Either cuts in spending or increases in taxes will be
necessary to stabilize the fiscal situation.”

This is more difficult to interpret than the blatant untruth uttered by Geithner. Is Bernanke denying that the
Fed is currently monetising debt like Geithner did, or is he saying that there will be no further monetisation?
If yields at the long end continue to rise, we’ll see if the Fed can resist further intervention? I doubt it, even
though it hasn’t worked so far.

A persistently annoying aspect of Bernanke misinformation is that inflation is always the result of strong
demand and the consequent tightness in utilisation rates across the economy. He never acknowledges that
inflation is generally a “currency event” rather than an “economic event” caused by currency depreciation

© Thunder Road Report - 8 June 2009 3

 and the resulting loss of purchasing power. He was at it again last week in his prepared testimony before
the House:

“the current slack in resource utilization will increase further. We expect that the recovery will only gradually
gain momentum and that economic slack will diminish slowly…In this environment, we anticipate that
inflation will remain low. The slack in resource utilization remains sizable…”

Bernanke is obviously so worried about the Federal Reserve’s perception in Congress that the central bank
announced last week that it is hiring its own lobbyist. The lady in question, however, is no ordinary lobbyist.
While Linda Robertson was an adviser to the two former US Treasury secretaries, Robert Rubin and Larry
Summers (who were the architects of the gold price suppression scheme), she also the headed up the
Washington lobbying office for Enron. See what I mean about surreal?

While Bernanke misleads, other world leaders remain deeply concerned about the prospects for the US
dollar. It was only 3 weeks ago that talks between Chinese Premier, Hu Jintao, and Brazillian President, Lula
da Silva, had preliminary discussions about settling trade in their respective currencies instead of the US
dollar. On Friday, Reuters carried a story that the Russian President is proposing that the dollar be dropped
in trade with China. Reuters picked this story up from the Russian press:

“Russia and China should consider switching to domestic currencies in bilateral trade without going to the
dollar, Russia’s president Dmitry Medvedev said in an interview with Kommersant daily published on Friday.”

It’s going to be interesting to see the implications for the dollar from the first “full format” meeting of the
leaders of the BRIC nations which takes place on 16 June 2009 in Yaketenaburg.

Besides the concern from the Russians, the Chinese and the Brazilians, it was the comments by Germany’s
Chancellor, Angela Merkel, on Tuesday which really piqued my interest. She was clearly unhappy with the
monetization (sorry “quantitative easing”) being practiced by the Federal Reserve, Bank of England and, to
a limited extent, the ECB.

“The independence of the European Central Bank must be preserved and the things that the other central
banks are doing now must be reversed. I view with a great deal of scepticism the extent of the Fed’s
powers and that the Bank of England developed its own small steps. The European Central Bank has also
bowed somewhat to international pressure with the purchase of covered bonds. Together, we must return
to independent central bank policies and policies of reason.”

It is very rare for a leader of a European nation to be so critical of central bank policies in public, especially
of the ECB. What was behind Merkel’s unusual outburst – even more so in a period of economic crisis?
I’m wondering whether it’s linked to a theory put forward by GATA supporter Bix Weir. He was fascinated
by a scene from the recent US television special, “Inside the White House”, which contained an exchange
between President Obama, Larry Summers the head of the White House National Economic Council and
someone who Bix Weir believes (correctly I think) is Austan Goolsbee – a member of the Council of Economic
Advisers and chief economist of the President’s Economic Recovery Advisory Board. The programme was
filmed in late May.

About three minutes into the broadcast (you can access it here), the narrator comments “The Germans
(Angela Merkel is named by Obama) need some attention by phone from the President. Larry Summers
has arrived to be in on that phone call.” The following exchange takes place before Summers suddenly calls
for filming to be halted:

Summers: Life has changed..ahh..since the briefing…ahh”

Obama: For the better or for the worse?”

Goolsbee: Net-net for the better…wouldn’t you say Larry?

Summers: There’s elements of both. The Germans...actually we should stop (the cameras) here.”

© Thunder Road Report - 8 June 2009 4

 In the Thunder Road two weeks ago, I highlighted how Jim Willie’s (of the Hat Trick Letter) source informed
him that the Germans had demanded that their gold stored in the US be returned to Germany. Bix Weir
connects this with the scene in the White House:

“I’ll bet my last gold Kruggie (Krugerrand – Paul) that the Oval Office phone call was a desperate plea to
buy more time before the Germans destroy the physical gold manipulation scheme.”

It’s an interesting theory and whether true or not, if you hold investments in gold and silver, at least you
are afforded some protection as events become increasingly surreal.

“Why do all you guys sit on your helmets?”

“So we don’t get our b*lls blown off”

After last week’s Thunder Road, the CEO of a leisure and hotel group emailed me to say that “You can’t eat
gold”. I agree (but it is a store of wealth) and, in my defence, would point to my other “go to” investments
in food/agriculture, energy and network infrastructure. With decent weightings in these as well, we can
aspire to the charmed life lived by LtCol Kilgore, the commander of the Air Cavalry helicopter squadron, in
Apocalypse Now:

“He was just one of those guys with that weird light around him. He just knew he wasn’t gonna get so much
as a scratch…”

Get your surf boards out and go surfing (not everybody knows how).

“If I say it’s safe to surf this beach, Captain, then it’s safe to surf this beach.”

Regarding food/agriculture (rather than surfing), I was having a beer with a savvy private equity investor
on Saturday night who was looking for deals in this sector. Besides the growth in world population, he was
swayed by the investments being made by China and others in agricultural land across Africa and parts of
Asia. I’d missed this, but as the Economist reported on 21 May 2009:

“Over the past two years, as much as 20m hectares of farmland—an area as big as France’s sprawling
farmland and worth $20 billion-30 billion—has been quietly handed over to capital-exporting countries such
as Saudi Arabia, Kuwait and China. They buy or lease millions of acres, grow staple crops or biofuels on it,
and ship them home.”

In keeping with my investment themes, a contributor to “Trader Wizard’, Bill Cara’s, blog highlighted last
week the attractions of Canada:

- Canadian prairies - wheat basket of the world;

- Oil & gas - plenty thanks, want some?
- Basic materials - got ‘em all;
- Precious metals – lots;
- Diamonds - yes, some of those too;
- Potable water - plenty thanks, want some?
- Non-carbon energy - plenty thanks, want some?
- Lumber - so much American producers can’t stand it;
- Health care - nobody dies because they can’t afford it; and
- Quality of life - wouldn’t trade.

It makes you think…

© Thunder Road Report - 8 June 2009 5

 Stock market standoff: Coppock versus Martin Armstrong
Coppock says buy
Last week, market strategists and technical analysts were highlighting the buy signal generated by the
Coppock Indicator, named after Edwin Coppock. After 22 years in the markets, I’ve periodically been aware
that Coppock was telling us to buy stocks, although I didn’t know what led to its creation (in 1962) or its
methodology. According to Wikipedia:

“Coppock, the founder of Trendex Research in San Antonio, Texas, was an economist. He had been asked by
the Episcopal Church to identify buying opportunities for long-term investors. He thought market downturns
were like bereavements and required a period of mourning. He asked the church bishops how long that
normally took for people, their answer was 11 to 14 months and so he used those periods in his calculation.”

In technical terms, it is the 10-month weighted moving average of the sum of the 14-month rate of change
and the 11-month rate of change. The buy signal occurs when the Coppock Indicator is less than zero and
begins to turn upwards. Coppock is, therefore, an indicator of medium-term momentum – it does not tend
to pick market bottoms, but generally indicates that a bull market in stocks is underway.

Coppock Indicator for S&P500

Source: Babak/Seeking Alpha

Coppock has an excellent track record of being correct with two major exceptions being 1991 for the
Japanese market and calling the bottom too early for the US in 2002. Redburn Partners’ leading technical
analyst, Nick Glydon, and respected market strategist, Albert Edwards, of SocGen both warned last week
that we ignore Coppock at our peril. That said, Glydon remains unconvinced on the sustainability of the
current market rally, while Edwards remains resolutely bearish.

In my mind the question is, why did the Coppock Indicator fail on those two previous occasions and are
they relevant for today? My suspicion is that they were related to high debt levels in both cases. When the
Japanese bubble burst in 1989, the economy was heavily burdened with debt following a real estate bubble.
In 2000 when the dot.com bubble burst in the US, the total debt/GDP in that economy was already 270-
280% - which had marked the peak during the Great Depression.

My point is that in heavily indebted economies, the initial bear market rally has a tendency to peter out
because of the sheer length of time required for consumer balance sheets to be rebuilt and for the impact
of expansionary monetary/fiscal policies to have an effect. What Japan’s “lost decade” seemed to show

© Thunder Road Report - 8 June 2009 6

 is that once the real estate bubble itself bursts, it’s incredibly hard to reflate the economy no matter how
loose the policy measures. This is why I’m sceptical about the sustainability of the widely touted “green
shoots” in the US and UK.

Martin Armstrong – Understanding the Real Economy

In contrast to the optimism of the Coppock Indicator is the work of the imprisoned (and he spent 7 years
without trial) financial genius, Martin Armstrong. I highlighted his report “It’s Just Time” (you can read it
here) in a Thunder Road back in April. As I said then:

“Martin Armstrong has made a very bold claim which amounts to nothing less than a holy grail for investors
and market commentators – he believes he has found the hidden order that runs through financial markets
and the world economy.”

Amongst its notable achievements, Armstrong’s Economic Confidence Model predicted the 1987 Crash
(to the day), the all-time in the Japanese stock market in 1989 (almost to the day), the bear market low
in 2002 (within a few weeks) and the onset of the sub-prime crisis in February 2007 (within just over 2
weeks).

From his prison cell in New York State, Armstrong has published a new report, “Understanding the Real
Economy” (here). As well as being an update on current events, he (as usual) provides deeper insights
into his multi-dimensional model. It was Armstrong’s use of this model which Eric von Baranov (of www.
kondratyev.com) claimed led a CIA insider of his acquaintance to tell him that “Martin Armstrong had to be
stopped”.

In the introduction to his report, Armstrong makes the wry observation that:

“When I was going to school, the economics professor told you everything was random and then the physics
professor explained nothing was random but was governed by laws. Clearly, something was begging to be
discovered that was lying beneath the surface in the world of economics.”

He goes on to make the point that it is the concentration of capital, i.e. movement of “hot money”, among
individuals, sectors and nations which is behind the peaks and troughs in the 8.6 year cycles which form
the basis of the core Economic Confidence Model. For example, Fed Chairman Volcker raised the Fed Funds
rate to 20% in December 1980 which broke inflation and caused the flight of hot money out of gold and
commodities and into the US dollar. This was followed by the creation of the G-5 in 1985 which led to the
coordinated collapse of the dollar and the flight of capital into Japan. The Japanese bubble burst in 1989
and money moved into the South East Asian economies. When that bubble burst, capital moved back to
the US (dot.com bubble) and Europe (ahead of the Euro), etc, etc.

“Each action caused a reaction setting in motion what we have today.”

The current 8.6 year cycle began in November 2002 (almost coincident with the October 2002 stock
market low as mentioned above), peaked in February 2007 (the onset of the crisis in the financial sector)
and remains in decline until a trough is reached in June 2011. This spells a very bearish note for economic
prospects and probably, although not definitely (see below), for the stock market.

© Thunder Road Report - 8 June 2009 7

 Turning points in the 8.6 year cycle

Source: Martin Armstrong

In his current report, Armstrong notes the similarity in the time taken from the peak to trough of previous
stock market bubbles:

1929 Crash: September 1929 – July 1932 = 33 months

Japan (Nikkei) December 1989 – August 1992 = 32 months

NASDAQ: March 2000 – October 2002 = 31 months

Armstrong argues that:

“the 31-34 month target for the possible major low is a universal pattern that I can only explain as it takes
just so much amount of time (sic) to cook an egg.”

In the current stock market context, he identifies the bubble top reached in February 2007 with the
financial stocks:

“Just remember, this cycle has been the concentration of capital in the financial sector where the trouble
really is, not the general corporate area.”

Armstrong’s message is that the 31-34 month target for peak to trough for a bubble means that financial
stocks could still face another big move down between now and September – December 2009 (31-34
months after February 2007). In keeping with this idea, I’ve noted the pressure being applied by the
FDIC on Citibank and wonder whether there is more than meets the eye? Martin Armstrong aims higher
- questioning the viability of the bank most deeply entrenched in the machinations of US government. A
failure of that magnitude would be a sight to behold. He argues:

“We are likely to see a continued implosion of debt that will cause the financial sectors to implode.”

While most bubbles come to an end with a 31-34 month decline, Armstrong notes that there are exceptions
which he describes as the “Waterfall effect”. This is a sudden and catastrophic collapse and the example he
cites is the collapse in the value of the currency of the Roman Empire in the third century AD. I wonder why
he chose that example and what relevance it might have to today! Just a few pages further on he argues
how the recovery in the Dow Jones in the 1930s was primarily due to it being a hedge against inflation
given the inevitable prospect of dollar devaluation at the time:

“the decline in the value of the dollar would cause the tangible assets to rise in proportion to the decline in
the dollar. The Dow became a hedge against inflation. It has retained that role.”

© Thunder Road Report - 8 June 2009 8

 This is my dilemma in terms of calling the direction of the stock market. While I remain bearish on the
economic outlook, the inflation hedge idea has its attractions (although PE ratios would likely contract).
This brings me back to where this Thunder Road began – the sell-off in US and UK government debt. If this
trend continues, where does all that liquidity go? As Martin Armstrong observes:

“Everything is inter-related and there is always a contagion effect that spreads on a correlated basis.”

Physical precious metals and commodities of all kinds would be a no-brainer in rampant inflation, but the
contagion would likely spread in a positive way to the stock market in general. Let’s not forget that during
1920-23 in Weimar Germany, the stock market went from just over 100 to 26,890,000 in local currency
terms.

© Thunder Road Report - 8 June 2009 9

 Author: I started work the month before the stock market crash in 1987. I’ve worked mainly as an analyst
covering the Metals & Mining, Oil & Gas and Chemicals industries for a number of brokers and banks
including S.G. Warburg (now UBS), Credit Lyonnais, JP Morgan Chase, Schroders (became Citibank) and,
latterly, at the soon to be mighty Redburn Partners.

Disclaimer: The views expressed in this report are my own and are for information only. It is not intended
as an offer, invitation, or solicitation to buy or sell any of the securities or assets described herein. I do not
accept any liability whatsoever for any direct or consequential loss arising from the use of this document or
its contents. Please consult a qualified financial advisor before making investments. The information in this
report is believed to be reliable , but I do not make any representations as to its accuracy or completeness.
I may have long or short positions in companies mentioned in this report.

© Thunder Road Report - 8 June 2009 10