Hedge funds and other forms of managed investment accounts are facing redemptions thereby forcing the liquidation of stocks, futures and a host of other financial assets. With fewer buyers than sellers, prices are forced down aggressively just to get rid of positions. We are in September, the end of the third quarter, when institutional investors will be trying to get rid of losing positions so they don’t have to report them in their quarterly statements. This puts additional pressure on an already depressed market, and it will happen again in December, and then again in March, June and September next year until they have nothing left that needs to be sold. Several hedge funds have already gone under and hundreds, if not thousands, will go bust in the months and years to come. That means there is still a lot of selling ahead of us.

Expect prices of financial assets to fall substantially below their fair value, or intrinsic value. For value investors that is a boon, but for those owning assets they are unsure of, it’s going to be a very stressful time.

The impact of declining metal prices should not be discounted either. In a bull market investors look for companies with marginal deposits because their shares offer leverage to metal prices. Any gain in the metal price will be amplified with gains in the stock price. In a bear market, when metal prices decline, marginal deposits lose value much faster than robust, high-grade deposits. Eventually the metal prices decline to a level at which the marginal deposits become uneconomic and their value tends to zero. Several companies have already seen their share prices decline to almost nothing as the market literally put no value on their deposits, and companies that continue to spend money on marginal projects are actually trading at a discount to cash.

But as rough as this year has been, I expect next year will be worse: even less liquidity, even more price volatility, and even more distressed investors who are forced to sell at any price.

Today’s release of commercial bank assets and liabilities contained the final data needed to complete the Actual Money Supply (AMS) calculation for August. The Actual Inflation Rate (AIR) for August on a year-over-year basis was 6.89%. This is the lowest monthly inflation rate for 2008; however, the average monthly year-over-year inflation rate for 2008, up to and including August, is 8.16%. This is still a very high rate of inflation. For comparison, the average annual inflation rate from 1960 to 1980 was 7.84%, and that was a period characterized by its high inflation rate.

While the monthly inflation rate has been declining since the peak levels reached in March I am still not at all convinced that we are heading towards wholesale deflation. There was a lot of brouhaha after several researchers stated that M3 had actually declined in July, and as I wrote in this letter two weeks ago (link), there was a corresponding decline in the Actual Money Supply (AMS) in July as well. As I also mentioned, we should be very cautious drawing conclusions from short-term economic data, as such data is notoriously volatile. Nonetheless, there is significant interest in whether the US money supply is in fact expanding, or contracting, so with the caveat that we should not rely on short-term data in mind, I can report that AMS increased between July and August. I do not believe one can draw any meaningful conclusions from the month-over-month changes in such economic data, but will state nonetheless for those who are inclined to disregard such warnings, that the month-over-month increase in AMS for August was 0.173%.

The bottom line, in my opinion, is that we are still in an inflationary environment and more time has to pass before we can determine if inflation has come to an end. The financial woes around us are begging for the creation of even more inflation and the current banking system has the capacity to create money at will. All that is lacking, thus far, is the will.