The train wreck that is the state of Illinois has generated a lot of questions lately, including “Will its government ever pass a budget?”, “Will it ever pay its overdue bills?”, and “Is it possible for a state to go bankrupt?”

Looks like we’re about to get some answers to these questions, along with one more: “What happens to the financial markets when people finally realize that Illinois is far from the only impending bankruptcy?”

Today’s Wall Street Journal has an anecdote-filled article illustrating what certainly looks like a case of terminal financial mismanagement (How Bad Is the Crisis in Illinois? It Has $14.6 Billion in Unpaid Bills):

Among the many, many data points:

• The state comptroller predicts unpaid bills will soon top $16 billion. “It is almost hard to say those numbers out loud because they seem so insane, but that’s where we are right now.” 
• Unfunded pension liabilities now total $250 billion. That’s about one-third of state GDP, and is in addition the myriad other debts taken on in recent years.
• S&P Global Ratings has warned that it could lower the state’s rating to junk as early as this week if a budget isn’t passed.
• Peoria-based OSF Healthcare, a network with 10 Illinois hospitals, is owed about $115 million for bills over four months old, the equivalent of 18 days of operating expenses.
• The state owes Illinois dentists $225 million. Some dentists with lots of state workers are selling receivables to keep the lights on. Others are asking state employees to pay in cash.
• The state owes two Springfield hospital systems more than $200 million.
• The Coliseum building at the state fairgrounds closed indefinitely earlier this year after the state failed to fund needed repairs.
• Eastern Illinois University has received $53 million less in state funding in the past five years than the previous five. Professors in the chemistry department haven’t been able to print in color since the department’s printer ran out of yellow ink a year ago. Enrollment has fallen from 12,000 to 7,000 in the past decade.
• If the state doesn’t pass a budget in the current special legislative session or allocate emergency funding, about 700 road projects under way across the state—worth $2.3 billion and employing 20,000 people—will come to a stop.
• Some social-services agencies are operating without state help while others have closed entirely, leaving some rural communities without mental-health clinics, domestic-violence shelters and drug-treatment clinics, despite a raging opioid crisis.
• Illinois has lost more residents than any other American state for the third year in a row, with 90% of the state’s counties seeing a drop in population, shrinking the state’s tax base. In 2016, a net of 37,508 people left, according to census data, putting the population at its lowest in nearly a decade.

 The impending downgrade to junk status might be the final push off the cliff, since Illinois – despite a constitution that kind-of-sort-of requires a balanced budget – still borrows a lot of money each year, mainly to fund its out of control pension system. As a junk-rated borrower, its interest costs will be much higher, making its financial imbalances that much worse. Assuming that anyone will lend money to the state on any terms.

Here’s a chart from CNBC showing how swift the fall from investment-grade has been:

Soon the junk line will be crossed, at which point it will become clear to everyone that the problem is unfixable and one or another doomsday scenario is imminent.

DollarCollapse.com

As the Mainstream financial media continues to promote the biggest market bubble in history, only a small fraction of investors are prepared for the disaster when it finally POPS.  The markets are so insane today, it seems as if fundamentals don’t matter any more.  However, they actually do if we look at the numbers closely.

In order to invest in the correct assets going forward, one must choose between those with a low RISK and high REWARD versus assets with a high RISK and low REWARD.  While this may seem like common sense, I can assure you, the market makes no sense whatsoever today.  And most investors are doing quite the opposite.  Go figure.

If we look at the following charts in this article, we can clearly see which of the following assets, the DOW JONES, GOLD or SILVER, enjoy the lowest risk and highest reward.

This chart shows the price action of the Dow Jones Index, gold and silver.  Since its low in 2009, the Dow Jones Index is up 229%, from 6,500 to 21,400 currently.  Even though the Dow Jones Index experienced a brief 17% correction in 2011, it hasn’t endured a healthy 30-50% market correction in over eight years.  It is most certainly overdue.

However, after the precious metals prices peaked in 2011 and then declined, silver is only up 22% from its low in 2015 and gold is up 20%.  Thus, the Dow Jones Index has surged higher for eight straight years, while gold and silver are still down considerably from their peak prices in 2011.

If we look at each asset class separately, we can see how over-valued the Dow Jones Index is compared to gold and silver.  The next chart shows that the gold price fell 46% from its peak in 2011 to its low in 2015.  Now, even considering the 20% current rise in the gold price from its low in 2015, it is still 35% below its 2011 peak:

Looking at the silver chart, its price movement is much more volatile than gold.  The silver price fell a whopping 73% from its peak in 2011 to its low at the end of 2015.  Currently, the silver price is still 66% below its 2011 high:

As I already mentioned, the silver price is only 22% up from its low in 2015.  Now, let’s look at the Dow Jones Index:

While the precious metals have experienced a healthy correction since 2011, the Dow Jones Index continues higher towards the heavens.  It is up a stunning 229% from its low in 2009.  If the Dow Jones Index fell 5,000 points, that would only be a 23% correction.  However, if it fell 11,000 points, down to 10,400, it would have fallen 51%, less than its 54% market correction decline from 2007 to 2009.

To get an idea of how overvalued the Dow Jones Index is, I am going to use the S&P 500 Index as an example.  Why?  Because the S&P 500 Index is up just about the same percentage as the Dow Jones Index since the low in 2009:

You will notice that the Dow Jones and S&P 500 charts are nearly identical.  So, what happens to one, will happen to the other.  To determine the fair value of the S&P 500, we look at the Schiller PE Ratio.  Basically, the Schiller PE Ratio (PE = Price to earnings ratio) is defined as the price (Index price) divided by the average ten years of earnings…. adjusted for inflation.

This historical Schiller PE Ratio mean is 16.8.  That means S&P 500 price is 16.8 times the average ten years worth of earnings.  So, if the Schiller PE Ratio has averaged around 16.8 in its history, what is the ratio today?

According to Gurufocus.com, the present Schiller PE Ratio is 30.2, or nearly 80% higher than the mean.  Not only is the current Schiller PE Ratio in bubble territory, it is even higher than the 27.4 ratio the last time it peaked in 2007.  Well, we all know what happened in 2008 and 2009.  During the first quarter of 2009, the Schiller PE Ratio fell to a low of 13.1.

Furthermore, before the stock market crash of 1929 and the ensuing Great Depression, the Schiller PE Ratio reached a high of 32.4 in September 1929….. only a few points higher than it is today.

So, what does that mean?  It means that the Dow Jones and S&P 500 Indexes are now in record bubble territory and their future reward is LOW while their future risk is quite HIGH.  However, if we look at gold and silver, we see quite the opposite.

Not only did the gold and silver prices experience a huge correction from 2011 to 2015, the current price of silver is very close to the cost of production.  Here is a chart of one of the largest primary silver mining companies in the world…. Pan American Silver:

This chart shows Pan American Silver’s estimated profit-loss per ounce (GREEN LINE), versus the average spot price (WHITE LINE).  As we can see in 2011, Pan American Silver made a $9.02 profit for each ounce of silver it produced when the average spot price reached $35.03.  However, as the price declined over the next five years, Pan American Silver lost money in 2013, 2014 and 2015. 

Even though Pan American Silver made an estimated $1.54 for each ounce of silver it produced 2016 YTD (last time I did the figures), it fell to about $1.00 and ounce during the first quarter of 2017.  With the average spot price of silver at $17.42 Q1 2017, my rough estimate is that Pan American Silver needs abut $16.40 +/- to breakeven.  With the current price of silver at $16.50, Pan American Silver isn’t making much money.

Moreover, my estimation for the average break-even for the primary silver mining industry is between $15-$17 an ounce.  I have not done any recent calculations for the estimated breakeven for gold, but it looks to be between $1,100-$1,500.  While the gold price has a bit more cushion than silver, we can plainly see that both gold and silver are much closer to a bottom than the Dow Jones Index.

According to this analysis, the HIGH RISK, LOW REWARD easily goes to the Dow Jones and S&P 500 Index, while the LOW RISK and HIGH REWARD belong to gold and silver. 

We must remember, when the Dow Jones Index suffered a mere 2,000 point correction at the beginning of 2016, the gold and silver price surged:

If the gold and silver price jumped 15% when the Dow Jones only fell 2,000 points in 2016… how high will their prices move when the Dow Index falls 5,000-10,000 points and suffers a 25-50% correction?  Because the entire market is held up by so much leverage and debt, I do believe the precious metals will enter into a new market of much higher prices.

Lastly, even though the Cryptocurrencies are getting hammered today, this is just an overdue correction.  Bitcoin and the other cryptocurrencies probably have a great deal more to fall before bottoming.  However, I do see some of the top cryptocurrencies to hit new highs in the future.  I mentioned this market because the same thing will happen to gold and silver.

All of a sudden one day and out of the blue, the price of gold and silver are going to surge higher.  Then the next day… they will have jumped even higher still.  Before investors or the public realizes it, the gold and silver prices will seem like they are too expensive to buy at this point….the same way when the cryptocurrencies shut up 200-1,500% in just brief period of time.

This is why an investor CANNOT TRY TO TIME WHEN TO GET INTO THE PRECIOUS METALS.  If one does not have a decent amount of physical gold and silver, it will be extremely difficult or likely impossible to acquire the metals when the prices have skyrocketed.  Sure, you might be able to get some metal, but the prices or premiums could be very high indeed.

So… as the folks who purchased Bitcoin and sat on them for several years before the huge move higher, the same thing will happen to gold and silver.   While retail gold and silver sales have fallen significantly, as well as precious metals sentiment, the fundamentals point to a LOW RISK and HIGH REWARD… if we are patient.

Check back for new articles and updates at the SRSrocco Report.

Chicago’s police pension fund won’t have enough money to pay benefits to retirees in 2021, according to a projection by Local Government Information Services (LGIS). At the end of 2020, LGIS estimates that the Policemen’s Annuity and Benefit Fund of Chicago will have less than $150 million in assets to pay $928 million promised to 14,133 retirees the following year.

This is the fate of state and local pension funds. There is a storm gathering on the horizon and of course these state and local governments will be raising taxes to try to stay afloat. The system is collapsing and it is totally unsustainable. This is the very same crisis that destroyed the Roman Empire.

….also from Martin:

ECB Declares Two Italian Banks Have Failed

Britain on the Edge of Collapse?

DUBLIN – Oil fell below $43 wednesday. Brick-and-mortar retailers are being emptied. The auto industry – including $1.2 trillion in auto debt – is stalling.

Meanwhile, restaurants are having trouble filling their tables. Consumers aren’t buying, perhaps because their incomes have gone approximately nowhere for decades.

House ownership is at its lowest level in half a century… along with employment participation. And consumer price inflation, as measured by the Bureau of Labor Statistics, is falling. So are Treasury yields.

All of these things – and more – point in the same direction: toward a recession.

Blinded by the Fed

Meanwhile, in a parallel universe centered in Lower Manhattan, prices for stocks still sell near record prices.

The stock market is supposed to look ahead. It is supposed to see more than any one person. It is supposed to detect signs of trouble long before they appear to the naked eye.

But it seems to see nothing at all. The subject of today’s Diary: What is the cause of this blindness? Who’s to blame?

Wasting no time on the evidence, we collar the culprit and get out a rope.

Why can’t the stock market see what is going on in the real economy?

Because the Fed poked out its eyes. It did this, we charge, by cutting the optic nerve that connects the equity prices to sales and profits.

A stock represents a share in an operating business. Investors have many different businesses to choose from. Until recently, they spent some time getting to know them and then made a decision about which was most likely to do best.

If he anticipated a cold winter, for example, an investor might buy a company that delivered heating oil. If he saw a new product flying off the shelves, he might want to own the company that made it.

A more sophisticated investor might even take out a subscription to Value Line and check the numbers.

Rise of the Quants

Today, the market is dominated by quantitative (or “quant”) hedge funds (those that use complex computer algorithms to trade in and out of stocks) and passive ETFs (stock-like funds that simply buy and hold indexes such as the S&P 500).

From a report by independent research firm 13D Research:

The rise of passive investing has been well-reported, yet the statistics remain staggering. According to Bloomberg, Vanguard [the world’s biggest provider of passive ETFs] saw net inflows of $2 billion per day during the first quarter of this year. 

According to The Wall Street Journal, quantitative hedge funds are now responsible for 27% of all U.S. stock trades by investors, up from 14% in 2013. Based on a recent Bernstein Research prediction, 50% of all assets under management in the U.S. will be passively managed by early 2018.

Passive ETFs do no traditional stock research. Instead, they rely on rudimentary algorithms, or sets of rules, when it comes to which stocks they buy and sell.

No algorithm ever went to a company meeting nor took the measure of the people running the firm. Nor do they care about the industry the company is in… nor its products. Nor do they attempt to make any connection between the real world of business and commerce and the stock price.

Missing Connection

Investor Steven Bregman, speaking at the Grant’s Interest Rate Observer conference, used the example of Exxon Mobil.

Suppose an investor, five years ago, was given advance notice of the future. He saw that the oil price would be cut in half. He knew that Exxon’s revenue, too, would be almost halved, with earnings down 75% and the dividend payout ratio at almost three times earnings.

What would he think? What would he do?

Surely, investors wouldn’t miss such a big swing in Exxon’s fortunes. The market would take in this new information and discover the right price for the stock, wouldn’t it?

But no. A share of Exxon sold for $82 five years ago. It sold for $82 yesterday.

What happened to price discovery?

How could a stock in a mature industry remain unchanged even as the price of its product (and its operating margins) have been halved? 13D Research again:

At the heart of passive “dysfunction” are two key algorithmic biases: the marginalization of price discovery and the herd effect. Because shares are not bought individually, ETFs neglect company-by-company due diligence.

This is not a problem when active managers can serve as a counterbalance. However, the more capital that floods into ETFs, the less power active managers possess to force algorithmic realignments. In fact, active managers are incentivized to join the herd – they underperform if they challenge ETF movements based on price discovery. This allows the herd to crowd assets and escalate their power without accountability to fundamentals.

The missing connection to the real economy has implications for the next stock market downturn. As they bought, so shall they sell. As prices fall, the quants, robos, algos, and passive ETFs will not trouble themselves to discover the value thus revealed.

They will simply sell.

How? When?

We don’t know. But we wouldn’t want to be standing in their way when the robots decide to run for the exits.

Regards,

Bill

Market Insight: Gold – Stuck in the Middle 

BY CHRIS LOWE, EDITOR AT LARGE, BONNER & PARTNERS

Today’s chart is of gold bullion going back over the past four years (to the start of June 2013).

To borrow a phrase from one of Bill’s go-to gold market timing experts, Dominic Frisby, these days, gold charts start in the middle and end in the middle.

If you’d bought an ounce of gold four years ago, it would have cost you $1,403.

Today, the same ounce sells for $1,255.

– Chris Lowe

The Newest Bear Market

From Jason Goepfert at SentimenTrader:  Crude oil fell into a bear market, at least by the definition of being down 20% from its recent high.

It’s been more than five years since the market fell so hard so fast from a high….continue reading HERE

…also from King World News:

ALERT: This Remarkable Indicator Is Flashing Major Warning Signals Like It Did During The Great Depression!