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Friday, October 29, 2010

Houses Of Pain....AKA.... "Forclosuregate"

The whole “Forclosuregate” or as some call it “Mortgagegate” fiasco has got me thinking what are the implications beyond the obvious. I think the best place to start so that you, dear reader, can have more of an understanding of the situation is with the components that make up this type of transaction.

For millions of Americans the dream of homeownership has turned in to the nightmare reality of loss or potential loss of their home.  We all know that the process begins with purchasing a house that will become a home with real people living in it. This post is not about rehashing how homeowners got in to the mess that we as a country face, I am sure dear reader that by this point you have read many articles belaboring this point along with who is at fault, believe me I know after all I live in Barney Frank’s district. Rather I want to delve into some of the aspects that are less well known that affect this “Forclosuregate” issue.

Let’s look at some background regarding the components of the mortgage that are involved in this mess. When a person or family decides it is time to purchase a house to make their own home, they will go find and contract on said property. Without getting in to the specifics of down payments and other factors let us just stipulate that they obtain a mortgage to enable them to buy their newly contracted property. The mortgage is approved, written, executed and the buyer receives the funding for the transaction.  The mortgages is a legal document that details all the terms of the loan including the term, interest rate, payment, and other legal stipulations including actions for nonpayment which include foreclosure.  At the time of the Mortgage, a UCC or mortgage note is filed which gives the holder of the note the ability to secure payment; in other words it allows them to collect the underlying asset to recover the principal loan amount (assuming it is still worth what the loan amount).  The note is filed at the state agency that handles notes, in some states this will be the Department of Licensing, in the same state as the property. The UCC or Note is one of the documents that is signed by the lender or their proxy and the mortgagee at the closing and gives clear legal representation of who owns the loan. The UCC is critical for a lender as it not only establishes the legal precedence for debt collection but also differentiates the lender as being first in line to get paid if there are multiple liens.

As a brief aside UCC stands for Uniform Commercial Code and all fifty states have enacted some version of the UCC, which is far better than the real estate laws which can not only vary from state to state but within each state as well. The UCC was created in 1951 by representatives from the National Conference of Commissioners on Uniform State Laws and the American Law Institute, to help give some uniformity to commercial laws between all the states promoting commerce. The UCC consists of 9 articles each pertaining to specific areas of commercial law, article 9 covers real estate. The UCC is a filing system and the mortgage note, the legal ownership document, is filed within the system and needs to be updated every 5 years or it can be expunged from the records which could cause the lender a problem.

Another key factor of the UCC is that it must be accurate and contain the proper legal name of the mortgagee and the property, as well as it must be filed in the correct jurisdiction. If the Mortgage lender has not adhered to the rules of the UCC and or filed wrong information or in the wrong jurisdiction it could result in the loss of the security meaning the mortgage holder would lose their claim.

The current excitement in the “Foreclosuregate” debacle centers around the idea that documents and who has what document to show legal possession. Many lawyers have been arguing that because of some minor technicality in the process that banks cannot foreclose; however, this is not a true situation. The idea has been further perpetuated by Obama’s threat to use his “pocket veto” to strike down legislation that had very broad bipartisan support that would allow for foreclosure documents to be accepted across multiple states; is it a coincidence that this veto which only serves to slowdown the mortgage clearing problem and begin the healing process comes just before the election. The legislation would not make it easier for banks to win foreclosure per se but it would clear many obstacles to fixing the problem. The bottom line is that if the mortgage is not performing as was stipulated in the contract and the bank that holds the legal right to the loan, meaning they are in possession of a valid mortgage note under the UCC guidelines, wants to foreclose then there is no legal way to stop the process even with notarization issues.

Lately there have been grumblings that Congress should pass a foreclosure moratorium even though the Obama administration is opposed to such a maneuver. The outcry for the moratorium push has grown since the banks themselves declared a moratorium, so that they could get all their ducks in a row before proceeding. The problem for a moratorium is that it is not congress’ place to do so as this is a question of “states” rights. The decision to place a moratorium on foreclosure is only empowered and enforced at the state level, the federal government does not have the expressed powers to enforce this type of moratorium at least not constitutionally (although that has not stopped the FEDs before). In my home state of Massachusetts the attorney general has called on major lenders agree to a moratorium on foreclosures and other states have followed suit which is what prompted the major banks to voluntarily stop foreclosures.

Ok so now dear reader we understand the basics of the issues at the heart of “Foreclosuregate” let us look at the some of the potential consequences and issues.

Let’s start with the FEDs since that is the last item discussed. If Washington were to step in to the fray here and force a moratorium on foreclosures it would have unintended consequences that could be very detrimental to our economy long term. Aside from the fact that the banks would stand to lose money which they should as they made poor decisions and should have to pay the consequences, the entire way we do business would be altered. The United States has enjoyed the most robust economy and deepest financial markets because of the way in which business was conducted in the past and the fact that we are a country of laws. Our economy was predicated on fair rules of trade, private property ownership and contract law. A moratorium on foreclosures would be yet another sign post on the road to banana republicville for the world to take note. The foreclosure ban would be an abrogation of contract law, and it would be the second large occurrence of it in the past couple years. The first very public incident of abrogation occurred during the financial crisis in 2008 when the Obama administration essentially demonized the bond holders of GM and Chrysler and violated the legal contract of the bond by forcing them to accept a settlement as opposed to being made whole as the law stipulates. The bondholders were made out to be greedy speculators, where as the truth of the matter is the bondholders were people like you and me as well as pension and mutual funds, you know dear reader typical enemies of the state. Not that I have any great love for the banks, but upholding the law is one of the key differentiating facts that separates us from a Russia or Central American economy. People buy in to America because they know what they can expect and their property rights are defended, unlike say a Russia who invites in oil and gas companies then takes over their discoveries and kicks them out. If the FEDs step in, it will have the unintended consequence of diverting investment and capital flow to other places on the globe out of fear that the US no longer respects the rules of the game and if it something is not to the US’s liking they will just change the rules. It does not just apply to foreign investment in our markets but also to investing in our government debt, which as you know dear reader, currently rings the register to the tune of $175 billion a month. Foreigners may not be inclined to invest in any of our markets and our own citizens may question if it is a good idea too. It is just a dangerous precedent to set.

Secondly, if we don’t let the system clear itself of all this debt and misallocated investment our economy will be stuck in low gear for years to come, just look at Japan who propped up their real estate sector after the burst of 1989. Granted things are different here in the US and will play out in different fashion than in Japan since we are a great debtor nation versus Japan being a great creditor nation; we will see much higher rates of inflation as opposed to the deflation Japan has experienced. In the late 80’sthe United States went through the S & L crisis and had experienced a steep run up in housing as well, but we dealt with that situation. The RTC or resolution Trust Company was set up and handled the liquidation process to clear the bad stuff out and in a short while things were moving again. Today it is more complicated only because the numbers are far larger but the solution is the same. The sooner we get the process moving the sooner house assets re-price and new owners who will pay the notes can buy and move in to stabilize real estate at an affordable level. I know no one, me included, wants to see the value of their home reset, but it is inevitable in this environment and lower prices will bringing the stabilizing factor of new buyers.

Third, because of all the slicing and dicing of mortgages and creating the mortgage backed securities and CDO’s there are bound to be ownership issues and many people and institutions will be hurt. Depending on how the UCC\Notes were filed or transferred will determine who owns what and who can collect. The securitization process of the CDOs and the selling and reselling has created a Pandora’s box that will have to be opened in the process. This in turn will come back to bite the banks and mortgage originators as people and institutions will sue to recover whatever funds they can. The precedent has already been set for the owners of the CDOs and mortgages to put the mortgage back to the bank when the FED and other banks filed suit against Bank Of America. This a problem that is measured in the trillions of dollars and mortgage put backs could be the death knell for some of the banks but will surely impact financial stocks going forward, and with the aforementioned institutions opening the door it will produce a torrent of claims as more institutions come out of the woodwork to sue lest they be sued by their investors.

Fourth, if a foreclosure moratorium was implemented it could have the unintended consequence of compounding the foreclosure situation. There are currently people living in houses that are behind in their payments, however, they have just made the conscious decision not to pay as opposed to not being able to pay. These are people gaming the system, living rent free and using the mortgage money to buy things, vacation or just fuel general consumption. It is reprehensible that people would take that kind of action and regardless of their rationale it is wrong, but none the less a moratorium would more than likely expand this type of behavior as there would be no consequence to acting in this manner; this is a classic moral hazard.

Fifth, this whole mess puts states and particularly municipalities at risk and relates back my “Municipal Jenga” post because it impacts budgets. If a foreclosure moratorium is imposed then Municipal revenues will decline. The reason revenues will decline is because if someone is either not paying their mortgage or in foreclosure then chances are they are not paying property tax either. This will add further strain to both state and municipal budgets as municipalities will collect less so their expenditures will have to go down via job cuts or the state will have to step in and help at  a time few states have the fiscal means to do so. At least if the foreclosures proceed and new people buy the houses at reasonable prices they are more likely to have a vested interest in keeping and financial means to pay for their new home, which includes property taxes.

So as you can see dear reader, there is no silver bullet and there are no painless answers. There are opportunities still to go short various segments of the market related to this mess as I do not believe that the market has priced in the true extent and impact of the problem. You can look at things like inverse ETFs that track the financials, individual vulnerable bank shares to short or even title companies. Additionally, homebuilders are going to struggle, so any that are too richly priced they will probably disappoint the markets and you can position for that.

We cannot forget that while this is a difficult problem to solve and is and will be painful for many there are real people that live in these homes. The whole foreclosure mess is a highly emotionally charged issue but it has to be dealt with in a way that will be beneficial for the well being of America’s future not just the unfortunate souls who are trapped in their own “houses of pain”. A phrase that Obama has used applies here, this is a “teachable moment” and hopefully many people, institutions and government can learn from this mess ; let us hope that they do.

Thursday, October 28, 2010

Rare Earth or Common Disaster?

China has been in the news lately regarding the fact that they control 97% of the world’s supply of exotic materials that fall under the Lanthanide group. If you think back to your high school chemistry class I am sure Dear Reader that you had to study the periodic table.  When it came to the Lanthanide group of elements they were glossed over as if they did not exist. Elements like Neodymium, Gadolinium, Lanthanum, Cerium, and thirteen other elements were not in as wide spread use as they are  today.  Today these elements are irreplaceable in many of the electronic devices that we take for granted ranging from cell phones, alternative energy windmills to precision guided bomb control systems. The general public is waking up to the reality of the Rare Earth dilemma. The US military is also keenly aware of the fact that it is dependent on China for components of many of its highly sophisticated weapons systems; to the military it is a matter of national security.

Just like Russia did with its natural gas embargo of the EU countries, China has flexed its muscle and threatened Japan that it would cut off its exports of Rare Earths to the island nation over the detention of a fishing trawler captain. Japan does not take this lightly as their economy requires these elements in many of their manufacturing plants to keep their export economy humming. While WTO rules prohibit countries from restricting exports of materials in order to force other countries to buy value added products, however, countries are allowed to restrict exports for conservation.  According to Chinese official Chao Ning of the commerce ministry the country only has between 15 and 20 years worth of the heavy and medium Rare Earths which are the ones used in the high tech applications.  This is posturing for the Chinese to be able to utilize WTO rules to control markets and potentially use Rare Earths as leverage against the US, particularity when it does not like specific policies like money printing, tariffs  or criticism of Taiwan etc...

Recognition that there is at least a temporary Rare Earths crunch and given its critical use in our economy congress is getting in to the act with “Rare Earths and Critical Materials Revitalization Act of 2010”  which provides grants and loans to develop rare earths projects. Many of the Rare Earth companies have skyrocketed in price over the last few weeks. A new market favorite is Molycorp (NYSE:MCP) a Colorado based mining company  which is looking to restart what was the world’s largest Rare Earths mine located at Mountain Pass in California.  The attraction to this particular company is that it is the largest formerly developed Rare Earth mine in the Western hemisphere. Additionally, MCP has a 30 year mine plan permit and environmental impact study both issued in December of 2004; which is a plus since these items can be a real hurdle and time delay to starting a mine. So MCP is a development mine with a twist since they have the permitting and proven and probable reserves of 2.21 billion pounds of Rare Earths with an average ore grade of 8.24%. In many respects investing in MCP is like taking a position in a late stage junior development company the risks stem more from the typical mining related issues that crop up. MCP currently produces 3,000 tons of Rare Earths for commercial applications, but expects to ramp up to 20,000 tons as it expands it facility in 2012.

MCP sounds like a slam dunk doesn’t it? Of course there will be competition from companies like Rare Element Resources (AMEX:REE) currently in development and drilling phase but has a 100% interest in Bear Lodge in Wyoming, which according to the USGS contains one of the largest Rare Earth deposits in North America. The competition goes beyond North America for example there is Lynas Corporation in Australia  who is proceeding along in its plans and recently penned a deal to supply a Japanese buyer .

Right now it appears that the Rare Earths mining companies(REMCs) could continue their rise, even Molycorp’s CEO was on CNBC, “I don’t believe that there is a bubble,” Mark A. Smith, president of the Greenwood Village, Colorado-based company, said in an interview with Susan Li on Bloomberg Television’s “First Up.” “These prices are absolutely sustainable and that’s really based upon the very simple facts of supply and demand.”

I hate to throw cold water on this run because it is one of the sectors that does seem to be really outperformning, but I have concerns. The current parabolic rise of Rare Earth stocks is unsustainable from what I can see. I do believe higher prices of the elements themselves are required to bring supply online , which is why MCP is moving now to increase production. The issue I have is not with the cost of the elements, but the REMCs have run parabolic while most have no real production at least not yet. MCP who is producing some material is valued by the market at $3 Billion while the entire Rare Earth industry’s total sales of $2billion , moreover they are carrying a large nut to finance their ramp up. Furthermore, there is the potential that many of the explorers for Rare Earths will come on line and affect Molycorp’s pricing ability. It takes time to bring a mine on line especially in the US but in other parts of the world the timeline can be dramatically shorter, so competition could appear sooner than expected.

It appears to me that everywhere I turn on TV or in periodicals the Rare Earths are being hyped.There is newly found concern over Japan’s ability to get Rare Earths as well as the US military and a growing recognition that the supply side of the Rare Earths equation has to be dealt with.  At the moment it seems like everyone feels that we will run out of rare earths and it is straight to the moon for prices. This reminds me of the Uranium “bubble” of a couple years ago and I think it is going to end the same way. Conversely, Uranium appears to be a hated asset at this time and I think would be a better investment than Rare Earths at the moment. I guess life is full of Ironies since as I have been putting this post together China is coming out and stating that they are resuming Rare Earth shipments, which comes as the release of the new Rare Earths ETF makes its debut. I see MCP and REE are taking large hits right now, the easy money has been made and just like Uranium patience will give you a better entry point. I guess we have the answer now it will be a common disaster at least for the moment.

Wednesday, October 27, 2010

We seldom repent of having eaten too little.

This topic prompted me to recall a couple of quotes:

“#5.  Pride costs more than hunger, thirst and cold.

#6.  We seldom repent from having eaten to little.”

Thomas Jefferson – “Ten Rules”

Since the people who put together the CPI statistics obviously do not eat, drive or pay for anything that a normal American might need to they can easily put blinders on when it comes to massaging their models to report low to no inflation. For the rest of us that actually go to the supermarket, put gas in the car, visit the doctor and live everyday life we can see the inflation first hand, which is what prompted me to write this blog post now. This inflation in our everyday lives shows up in many ways, some obvious and some sneaky. A sneaky way that inflation creeps in to our lives every week is at your local grocery when you buy the items to feed yourself and or your family. On the surface it may appear that prices are stable but nothing could be further from the truth. For example, the last time I was in the market I had to pick up some Edy’s ice cream and pasta, which are pretty close to the cost that they have been for a while. Upon closer inspection of these products one discovers that while the price out of pocket may be the same the actual volume of product you get has been trimmed. The ½ gallon of ice cream is now 1.5 quarts instead of 2 and the box of pasta is no longer 1 pound but instead 13 ounces. This is how food manufacturers are dealing with input cost inflation since they don’t currently have the pricing power to charge what they need to for the old volumes.

Food prices are rising because there have been a variety of crop issues around the world and they are impacting global production at a time when the world’s stockpiles of certain commodities are down. Moreover, food is not a product that you can just print up or expand flow by drilling a second well on a proven reserve. Food production takes time and there is nothing that can be done to truly speed up its production. If a harvest is poor you have to wait until the next cycle to plant and re-harvest; so while demand may be stable or growing “mother nature” does not help out in this area.

On October 22nd a Bloomberg report appeared discussing the record crop in India which is helping India’s credit market, but this is more the exception than the rule. The net result is that India with its 1 Billion plus population may be able to stave off inflation for its people but it is not in a position to fix the problems of the rest of the world. Conversely, the crops from around the world have been affected negatively by everything from Russian Drought cutting their harvest by 1/3 and drought in Germany causing crop failures. Meanwhile, there are actual locusts in Australia rivaling those described in biblical plagues are chowing down on the wheat down under. Even Canada is expecting their wheat harvest to be down some 35% due to extraordinarily heavy rain fall as is Pakistan where their wheat crop has been flooded out. Lest you think dear reader that this only applies to wheat; in West Virginia they are losing their apple and soybean crop to the tune of 86% and 83% respectively. Nepal has suffered from a massive corn crop failure as well as South Africa.

I an interview with Don Coxe, a world leading expert on agricultural commodities, he states his belief that there is the potential the world could face a “Mass starvation” following North America’s next major crop failure.  Coxe points out that "During this decade, the annual increase in hectares of global cultivated farmland has been roughly 1.5 per cent, at a time global demand for grains and soybeans has been growing at double that rate". Additionally, the article mentions that the global financial crisis has left farmers scarred and has caused them to curtail their output. He also mentions a theme that is tied to other investment strategies like the “arms dealers”,; which is the rise of China and India and their demand for more protein rich diets will divert staple crops to feed purposes reducing further availability and driving cost. One thing that Coxe does not discuss is the tie in with water and how much water is required to raise the protein stock versus the equivalent in protein rich crops like soybeans; yet another investment theme going forward.

Coxe also discusses how, "We've been incredibly lucky with the weather up to this point. But if you cut the growing cycle by four weeks, that will dramatically reduce yields”. The fact of the matter is that the climate has changed and whether you believe it is man-made or a natural cycle is irrelevant; instead we need to focus on food production in the new environment as soon as possible.

Add prior facts that the world population currently stands at around 6.5 Billion and is expected to grow anther 2.5 billion in the next 35 years, so we will need to figure out how to feed them. In the future the crop disasters of today will be even less tolerable than those of today and will further drive costs.   If you are interested dear reader you can check out the World Agricultural Supply and Demand ESTIMATES form the USDA in PDF format to see what the government is telling us is going on in the food supply.

At the same time that all these issues have come to the fore regarding crop production the UN issued a report on October 21 that the world is losing arable farmland at an alarming rate of about 75 million acres a year or roughly the equivalent of and Italy a year. The losses are due to farms being paved over for urbanization or industry as well as environmental degradation.

As for the United States the number of farms as of the latest data available from the USDA has held steady at 2.2 million, however, overall acreage has declined by 110,000 acres. The statistics also show that 1.2 million of the farms have revenues of less than $10K per year and another 660K farms have revenue between $10K and $99K. One has to wonder of all those farms how many are able to actually hang on in this atmosphere where their inputs are rising, it is an important question since these farms make up 81% of all farms in the US.

So as you can see Agriculture has its issues and is related directly or indirectly to many issues and areas of the economy from population and land to water and fertilizer. So how does one play this trend? First as I mentioned earlier agriculture is a trending business since if there are issues they are generally only correctable the following year at best assuming that crops and or weather cooperate. Just a month or so ago right on the cover of Bloomberg BusinessWeek was a headline touting their article “Don’t’ buy DBA” or commodities for that matter. When things appear on the cover of BusinessWeek it is usually a contrary indicator just as the proclaimed “the Death of Equities” in 1982.

For those of you who are unfamiliar DBA is the symbol for and ETF that trades on the New York Stock Exchange, AKA Powershares DB Agriculture Fund. DBA is a commodity based price index that reflects most of the major crops from wheat, sugar, corn soybeans, coffee, cocoa and even some cattle and hogs.  This is a far safer alternative to playing in the futures market for exposure to the “softs”, that is not to say DBA it is without risk, but it is kind of like a commodity mutual fund for diversification and less wild exposure.

Now that you have the raw materials covered I would look to the “arms dealers”; in this case being John Deere, Monsato, Mosaic, Potash, Willmar International, Caterpillar, Yara and  Bunge to name a few. Depending on the size of your investment funds you could put together a nice basket of all these and other stocks that supply or aid the agricultural sector; or as you may have guessed like the tag line for the iPhone “there’s an app for that” in this case it is an ETF.  Market Vectors Agribusiness ETF trades on the NYSE with the very appealing ticker MOO. MOO gives you exposure to the “Arms Dealers” both in and out of the United States, this way you get a the added benefit of increasing earnings from a falling dollar. Some of the companies in the MOO portfolio are located outside the US but most of them sell outside and can earn even more if the dollar continues on its current trajectory.

DBA has a $1.9 billion in net assets and MOO has $1.5 Billion, so they are not small funds and  they trade an average of 1.7 million shares and 850K shares a day respectively, so you will not have difficulty in buying in or selling out. As with most securities these days but even more so with commodity related stocks it can be very volatile and people are easily shaken out.If one is going to invest in these areas they should wait for a pull back and use trailing stops as well as demonstrate patience recognizing that this is a longer term hold.

Looking at the charts of DBA and MOO they appear ready to correct as they are overheated and could use a healthy consolidation. As a disclosure I am looking to own both of these ETFs at slightly more attractive entry points, but dear reader you need to do your own due diligence as this is not a recommendation to buy or sell these securities. Just looking at the charts I am looking for a pull back to the 50 Day moving average on both DBA and MOO. Both ETFs are clearly in a nice uptrend and both sport a bullish cross of the 50 day MVA up thru the 200day MVA, but they are both overbought on declining volume meaning that the move is getting long in the tooth and needs to take a breather. In fact MOO looks like it hit a temporary peak on very heavy volume even as its relative strength appears to be waning. As I said I am looking for a drop toward the 50 day MVA to imitate a position in both ETFs. As a side note both ETFs look good on both the daily and weekly charts so the confirmation of the uptrend is in two timeframes which think speaks volumes. There have been many times in my investing career where it is not as clear because and issue will look very good in a shorter timeframe but still be in a serious downtrend for a longer term view; this is not the case with DBA and MOO as they have based for several months doing the sand paper grind riding themselves of the weak hands.

DBA Daily Chart (CLICK the image for a full size view)

DBA Weekly

MOO Daily

MOO Weekly

Tuesday, October 26, 2010

The More That Things Change The More They Stay The Same...

The way the news comes on the economic front these days at dizzying speed it is enough to overload and boggle the mind. On a daily basis we hear about a scandal, bank failure, flash crash, quantatitive easing, “mortgagegate”, regulation, tax increases, recovery, no recovery, job losses, job creation and the list is endless.  It is hard to make heads or tails of what is going on.  Today I want to look at couple items in the vein of can you really have confidence in the markets or government based upon readily accessible information. Daily we have stories popping up pointing out both the problems and corruption in the aforementioned areas; so who do you trust? The key is to think for yourself and form your own opinions based upon what you know and if you don’t know about the specific area research is required. It takes time and thought to read between the lines of what is reported, however, it will be your savior over the long run. You must always think for yourself and question what you read, don’t just take everything at face value. The reason you must question is that the news sources that we are exposed to are all biased to shape the readers view; gone are the days when journalism was unbiased providing just the who, what, where, when, and why.

The first item I want to discuss dates back to my blog post entitled,” Unintended Consequences Galore”  which was related to the report being presented by the SEC with the intent of bringing confidence to the markets in the aftermath of the “Flash Crash”.  I had argued that the report would not inspire the desired confidence and did nothing to address the issues regarding high frequency trading or algorithmic trading; as a result nothing will have truly changed in the market. In the time since the SEC report announcement has transpired the markets have risen, yet the small investor that it was targeting to shore up has continued to plow more money in to bonds (MOAB). In fact an article appeared on yahoo finance that has an analyst who is making the claim that the market is just high speed guys chasing each other rather than a true rally; it is a pretty good short read you can find here and it goes along with my point.

In a related item, not even a month after the unintended consequences post comes a Reuters article, “CTFC takes aim at “runaway robotic trades”:Chilton”. The gist of the article is Bart Chilton, who is a genuinely concerned CTFC regulator, talks about holding the algorithmic trading companies accountable, since it has cost people money and obviously added to the sapping of investor confidence in fair markets.(emphasis mine). This seems like just another example of MOPE as opposed to any real action taking place, listen carefully can you hear the Goldman boys or Morgan guys shaking in their boots over this…no …I did not think so. Now while Chilton is as I mentioned a good guy, the CTFC appears to move to protect the investment markets from rigged or unfair practices at the blazing fast pace of a snail stuck frozen to a block of ice . How long has the CTFC been reviewing the manipulation on the short side of commodities? The CTFC held hearings and took public comments and much discussion has taken place, but the action on this has been taking place at such a glacial place that an entire solar system starting from hydrogen gas cloud could have formed already. In other words, from the CTFC perspective they are saying; yes there is a problem and we hear you maybe we will get to it or not as we would not want to actually stick our necks out and fix anything. Now this has to inspire market confidence. As the title of this post implies the more that things change the more they stay the same.

The next item up is an article courtesy of Bloomberg, “Treasury Shields Citigroup as Deletions Undercut Disclosure”. Back in January of 2009 a Bloomberg reporter, who has subsequently passed away, named Mark Pittman filed a FOIA(Freedom of information act) request for documents pertaining to what the $300 plus Billion in Citicorp securities the US Government backstopped. Well thanks to our new transparent government it took a new and improved 20 months to get the materials, which I guess is better than the prior timeframes? The information, which one would normally assume pertains to investments of one form or another held by Citi don’t require “eyes only” top secret security clearance to view. The resulting data dump from the FOIA request was 560 pages of various emails like something out of Clancy novel.  The Treasury must have bought stock in Sanford the maker of black sharpies as the majority of all the emails were blacked out. Was it really necessary to black all this information out? Who is being served here Wall Street or the people whose money is doing the heavy lifting, the US Taxpayer. It is called the Freedom of Information Act for a reason, but I guess that does not apply to Wall Street or the Treasury. What information could have been in there that would compromise national security or did Citi take such risks that they are truly belly up and being protected because they did some illegal activities? I wish I knew the answer but either way we are paying for it but no one is accountable, and this is all taking place even after the President’s pledge for more transparent government. I would view this as a black eye in the trust department. As the saying goes”the more that things change the more they stay the same”.

It is the continual barrage of stories and events like these that are undermining not only investor confidence but confidence in the system itself. The tide on all this corruption is changing slowly and has given rise to the Tea Party, which the Left and the Mainstream Media summarily dismiss as kooks or haters; a similar method the Goebbels would have used to discredit something that shines the light of day where it is unwanted. I am not saying that I endorse the Tea Party but you can plainly see what has given it birth and continues to fuel its growth regardless of the media’s continual attempts to report its premature death. Just a few minutes ago I was notified of a Rasmussen poll showing only 14% Prefer Government-regulated Economy Over Free Market, so there is hope yet that we have not completely slid off the cliff to socialism, but time will tell.

All the American people want is for their leaders to come clean at this point. The American people know it is bad but they are being kept in the dark as to how bad it is and how bad it could get. The failure to clean up the improprieties and cover up malfeasance in the markets is like continuing to blow up a balloon beyond the point of its elastic capability. America was based upon the idea of a fair shake to succeed or fail based upon one’s merits and yes sometimes luck, but not favor one group at the expense of another. Corruption and the move away from out roots has been the way for the last 40 or so years…The more that things change the more they stay the same, until they don’t!

Monday, October 25, 2010

Ben And Timmy's Not So Excellent Adventure....

It is Monday here in Boston, MA and the fog of the G20 has lifted while the FED storm clouds remain parked on the horizon. The G20 was Turbo Timmy’s attempt at MOPE(Management of Perceived Economics) and it obviously has left him mopeing.  Just for a moment we will leave our bumbling protagonist to mention the second bumbling character in our dark comedy Ben “B52” Bernake. I have no proof of this but it appears that the negative statements that were coming out regarding QE2 last week were coordinated because Ben and Timmy knew ahead of time the outcome of the G20 that no real agreements would be reached and they needed to enact some jawboning or MOPE to mitigate the market run up but at the same time create a distraction to avoid a potential market meltdown.

Back to Turbo Timmy and his spectacular performance at the G20. I am sure dear reader that you are smarter than the average American and took many of the pronouncements prior to the G20 with a grain of salt, since you knew or at least suspected that there would be no agreements reached as I detailed previously in my “What Ya Talkin’ Bout Timmy” and “Theory Vs. Reality” posts.  I know dear reader you may be thinking that I am beating a dead horse at this point but I would submit to you that there are a couple factors in play, including the G20 meeting outcome, which will affect and shape your investment perspective.  Obviously the first is the G20 meeting, however, there still is the Nov 2 midterm election as well as the Nov 3 FED meeting.

For the moment let’s focus on Timmy and his accomplishments at the G20. Timmy came out with a plan that I mentioned in my blog post, but appeared originally in the Wall Street Journal, which stated that his goal was to move to rebalance the world’s economy and fix the currency balance too. Now dear reader you don’t have to be a market expert to understand that this idea did not have a snowball’s chance in hell of being agreed to, you just have to understand human nature. It is basic human nature that one is not going to agree to things that you perceive as limiting or harmful to one self or one’s country. Human nature also explains other market dynamics but I will cover those in a different post as they don’t directly pertain to this conversation.

So what is the result of Timmy’s adventure in Seoul?  For starters we got a verbal pledge from most of the ministers of the countries present that they would try to avoid competitive currency devaluations aka currency wars. How effective will this pledge be? I give it a week tops. Once again human nature dictates here it is not what is in the best interest of the world economy but instead the individual players or countries. The net result is that this pledge will be unenforceable and as steadfastly held to as the scene in Monty Python’s “Holy Grail” where Arthur’s brave Knights run in to a spot of trouble and their battle cry becomes “run away, run away”. This pledge has even less sticking ability then OPEC’s pledges not to cheat on oil production quotas even when the quotas are in their collective best interest.

The second significant thing to come out of the G20 is the fact that while the nations pledged not to engage in a currency war, not a one of them was willing to relinquish their sovereign right to manipulate their currencies up or down as they see fit. No one wants to be the loser in the race to the bottom.

To go one step further as I had put forth the premise in my post “Do As I Say Not As I Do”, Germany and China have woken up to the fact that US is doing exactly the opposite of what they are preaching. The US under the leadership (or lack thereof) of Ben and Timmy are issuing debt and running the printing presses respectively, while pushing for stabilization pacts and global rebalancing. The problem is that the US’s credibility has been severely tarnished so other countries do not trust the fiscal leadership coming from Washington as they see that every proposal is geared toward “extend and pretend”. The rest of the world has figured out that the current fiscal philosophy is designed to maintain the power regime in Washington by trying to mitigate the debt bubble damage and keep the “sheeple” from feeling any pain if possible.

Many of you have heard the old fable of the frog in the pot where the heat of the water is gradually raised so it has no sense it is being cooked; unfortunately this is the fate of the US.

To add to the currency problems are the debt problems of the US. I had detailed in an earlier post  entitled “MOAB Mother Of All Bubbles” with the recommendation to avoid US treasury debt due to it being a bubble particularly the long end. Many people and institutions have been running to the perceived safety of the US Treasury market. It is still a mistake to run to Treasuries as Ben and the FED have painted themselves in to a corner. Over the past year the FED has monetized approximately $1.7 Trillion and we still need inflows of $125 Billion a month to buy our debt to keep the wheels “on the bus”. At the same time we are running a trade deficit of $45 billion a month meaning in essence as a nation we are consuming roughly $170 Billion a month of the world’s capital, no chump change. To add fuel to the fire Ben’s excellent (insert guitar riff here) plan much of the debt and deficits on the order of 65-75% of it was and is financed at short term rates instead of 10 or 30 year rates.  The implications of this financing is that trillions of dollars of debt will be rolling over in 2011 and 2012, since the favored vehicles for Ben are the 3 and 5 year note and the crisis began in 2008. Why should you care dear reader? In the near future will the US will need to finance more debt and simultaneously we will have to refinance the existing issues coming due; so in essence it will be like financing double the amount and that my friends is a whole lot of coin! Additionally, 70% of all the US debt has duration of 7 years or less which will just be pouring more gas on the fire.

So while this has all transpired the US has sold its debt to other central banks and commercial banks but the fact that sends up warning flares for me is that $900 Billion has moved in to Treasuries and bond funds from John Q over the past couple years. There has been much talk about the withdrawal of funds from the equity markets, well where do you think they migrated to dear reader? Here is where Ben’s excellent adventure becomes treacherous. Ben understands the precarious nature of the economic situation we currently find ourselves in, but what is he to do? The rhetoric has been running hot and heavy and that has gotten him quite a way along on this adventure, but there comes a time which is rapidly approaching where he will have to $h1T or get off the pot. Ben knows that neither the economy nor its citizens would cope well with rising rates at this point so he has a conundrum; does he sacrifice the economy or the Dollar? My money for what it is worth is on the Dollar, however, the market will ultimately dictate the outcome that Ben will not be able to stop.

You see dear reader that as Ben sacrifices the Dollar on the altar of Keynesianism, people around the world are not stupid and will demand to be compensated for the redcuction in purchasing power of the dollar. The net result of the demand for compensation will be that the market will force rates across the yield curve higher.  The US economy will not handle the rise in rates very well so there will be screams from the market to save us Ben. At first the FED will be reluctant, but it won’t take long before they begin QE3 then QE4 etc… The FED will find itself caught in a viscious cycle as each time they QE to stem the rate rises the Dollar will take it on the chin. The Dollar weakness will in turn fuel domestic inflation and drive the deficits higher and lean on interest rates again. This is all reminiscent of what has happened to every FIAT currency which is not backed by anything tangible over time from Ancient Rome, late 1700's France, Revolutionary US, Weimar Germany and more recently Argentina. The deflationists argue that this type of scenario and other inflationary scenarios will not play out because the FED won’t purchase these so called assets, to this argument I say well they already have and Ben will use “emergency powers” to justify purchasing whatever he sees necessary. They will also argue that Ben and the FED won’t do anything that might damage their balance sheet; to which I say why? Has the FED under Ben not already exchanged Trillions in Toxic assets from the banks, is that not a precedent? I believe that the FED and Ben are no different than the habitual gambler that is down on his luck who maxes out his credit cards to gamble again to get even. If the financial system is in a tailspin Ben will buy everything and anything taking on the risky assets rather than let everything circle the drain where you can be sure dear reader that Goldman Sachs will be waiting.

This diatribe is yet more justification, dear reader, to buy tangibles and stay out of debt.  There are those that point out that there were recently 95% bears in the dollar ant therefore tangibles would fall as the dollar rises, however, that has not borne out and the dollar has barely rallied and alleviated much of the oversold condition. Moreover, I did a quick study using the ETFs NYSE:UUP (Dollar Bullish) and NYSE:UDN (Dollar bearish) to see where the general public is regarding their feelings about the dollar. It would appear the public buys Timmy’s stance on the stronger dollar, which you can see in the chart I plotted below. It seems to me that this is a better predictive indicator since like options player and odd lot sellers the public generally get it wrong and since the bloodletting in 2009 they have been bullish on a proportional flow of funds based on volume and dollar value. The exception in 2010 was on 5/27 where the ratio fell to .9 and change, indicating that more dollars were flowing to the dollar bearish ETF.

I have attached some charts below (you can click on each chart to enlarge) for your review and tomorrow I am sure there will be plenty to talk about as I see Ben is blabbing on the flat panel again and Mr. Obama has turned in to the newest “Deficit Hawk” …uhh ..yeah…right! Till tomorrow….I remain your humble author stuck on Ben and Timmy’s Not So Excellent Adventure…!.

Note from late 2009 the general public has been buying the Dollar Bull ETF and the trend continues. Just like the odd lot buyer is an indicator of being on the wrong side of the trade so is this.

The chart shows how little movement in price was required to temper the "oversold" condition of the dollar meaning there was not much real strength behind its rise.

I have noted prior inflection points in the gold market and you can see while none of the points exactly matches the other they all rhyme pretty well.

Friday, October 22, 2010

Theory Vs. Reality...The Timmy Syndrome

I hate to be a pessimist, but it pains me to see the stupidity that goes hand in hand with the constant rosy optimism and green shoots mentality. Yes, as Americans we are inherently optimistic and I am all for that sentiment as it has made this country great and gotten us through tough times in the past.  In days gone by we would work together as nation to overcome adversity, but today everything is fractured between political interests and corporate interests. Moreover, somehow the can do spirit of America has turned in to the fix it all powerful government, make the problem go away I want no pain society.

Now I am not one who believes in pain when it can be avoided, however, there are times where we have to take our medicine. This refusal to allow the economic medicine to be administered goes back to the Bush administration and prior. I would argue that the seeds for all of today’s problems germinated under the Greenspan FED, of course Brenake being a disciple has taken the gospel forward and compounded our problems.

In professional sports there is a saying that between each pitch or play that you need to clear the mechanism. For example a major league pitcher has to make each pitch separate from the prior pitch, especially if things did not go exactly as planned on the last pitch. If the pitcher does not do this then it usually leads to a worsening situation where errors are compounded. Most if not all the problems we are having today are because the economic mechanism was never allowed to reset. The problem now is that it is impossible to reset the mechanism without devastating the economy and many innocent individuals too.  Things are too far gone for an easy fix, the window for the easy fix closed during the Bush administration since we did not “organically” grow the economy instead we put it on easy money steroids. Sure the economy boomed and looked good, but it was not healthy. It is no different than reports you hear about athletes that take steroids and look like an Adonis today only to become debilitated due to an enlarged heart or other complication of the steroids years later.

In the case of the economy the steroids are a cocktail of excessive cheap money and debt both public and private. Each day that goes by and more of the economic steroids are applied we get stranger outcomes. The problem is that the situation has gotten so far out of control that if the merry go round was stopped it would be very painful. This is not to say that we will not have to face a reckoning day, we will and it will be painful particularly for those with high debt levels or who are invested exclusively in paper assets only.  The government can’t and shouldn’t have tried to fix this mess early on with the drug of cheap money; if they stood aside then we would be in a completely different and better situation now.

So what is the fix of the day? Is it he FED or the G20… Does it matter? As I write this the Dollar is treading water, Gold is down and the Dow is down too. So what is going on? There are a combination of factors that have gripped the market and caused the role reversal of the market and gold versus the Dollar.  Ever since the August meeting in Jackson Hole when Mr. Bernake came out and stated that the FED wanted to set a higher inflation target and mentioned QE2, the markets took off like the space shuttle. Adding fuel to the fire others at all levels of the FED came out in support of Bernake’s statements and dear reader as you know from that point on the markets were rockin’ and rollin’. All markets were up and every inflation gauge outside of the FEDs gerrymandered CPI were heading straight for the moon. At the same time the Dollar which the FED is trying to manage down in an orderly fashion appeared to be at the precipice of a severe decline even though it was technically oversold while gold was technically overbought. Now personally I believe in bull markets and bear markets with normal market forces in play and individuals are left to their own devices overbought\oversold indicators are less useful because the supply of buyers or sellers keeps expanding as new entrants find their way in particularly in smaller markets like gold and silver. If one has any doubt about this then go back and take a look at some charts from the 1998 to 2000 period and you can find many stocks that stayed overbought for months and continued to go up.

So over the last couple weeks it looked as if happy days were here again and things were getting to far ahead of themselves for Bernanke and Turbo Timmy’s taste. The result is you had the minority hawkish fed governors like Bullard and then Hoenig yesterday making temperate statements regarding the QE2 prospects, which threw cold water on the markets and gave the Dollar a footing.

The next issue coming to the fore is the G20 meeting in Seoul Korea. Documents were “leaked” showing that Turbo ”Timmy” has a grand trade balancing plan that would use budgetary process to curb trade deficits and boost exports. He is also calling for G20 members to refrain from using competitive devaluations of currency and suggested a target of no more than 4% surplus or deficit as a percentage of GDP.

All I can say is WOW! I guess all the money Turbo “Timmy” saved by evading taxes must have gone in to some good drugs. One has to ask what is the color of the sky in “Timmy’s” world? First off there are already reports of noncooperation leaking out of the G20 meeting and what would one expect based upon the history of the G20. I mean seriously when it was only the G7 there were occasional agreements, but now with 20 diverse nations each with a self interest you are expecting agreements especially anything that would help the US, please!

Timmy is proposing the put a 4% cap on trade deficits and surpluses he is out of his mind. Under the structure of the economic world in its present from there is no way we can get the trade deficit\surplus figures to jive. We don’t live in zero sum world although the current administration would like to implement this; it still works out that for every winner there is a loser. Even Japan's Finance Minister Yoshihiko Noda on Friday called the idea of targets "unrealistic.". Of course it is unrealistic to Japan with their own economic problems if they had to cut their exports to meet the 4% trade surplus number it would probably collapse their economy as they are so dependent on exports since their stock market bust of 21 years ago.

More breaking news that Timmy's grand plan is not viable comes to us from a CNBC report. "We didn't expect much to happen. We didn't think that the fundamentals brought them to a place where they could have some agreement," said Robert Sinche, global head of foreign exchange strategy at RBS. "Obviously (Treasury Secretary Tim) Geithner's poposal on some quantitative targets is being shot down. I just don't think they have any common ground on which to agree on things." I am sure you are shocked dear reader, as shocked as when you watch your favorite movie again but this time expecting a different outcome.

It is not written anywhere, but obviously “Timmy” believes that all the countries will put aside their own self interests to help the US out of its pickle. If we actually had free markets then everything would balance itself out over the long term, but imposing a management scheme like this will only lead to distortions and new problems. Again the EU is a living example of managing economies or deficits by decree sounds great in theory but fails in practice; just look at Greece, France, etc….

We cannot have a closer balance of trade with China for example because while we still manufacture products in the US we don’t manufacture nearly enough nor at a price that is competitive for world buyers at least not without an even lower Dollar. I don’t mean to pick on China alone because the same problem extends to most countries. Ironically a lower dollar would solve this problem in the long run but it would not be an easy painless fix.

How did the US get in to this position?  We can look at some of the statistics that highlight why we the trade deficits cannot be gotten under control. For example since 2001 about 42,000 US factories have either moved overseas or shuttered all together. These are jobs that may never come back and cause a shrinkage in the amount of product we can export to offset trade deficits. Since 2000 we have lost upwards of 5.5 million manufacturing jobs along with those factory closings. Many of the same companies that closed factories here are increasing employment at foreign factories which adds to their bottom line but continues to hollow out the middle class and increase the trade deficit. We as a nation are not energy independent and have to import over 60% of our petroleum needs which fuels the trade deficits even further.

The bottom line is that while the bubble economy was in play and people were employed the trade deficit did not matter nearly as much. In fact one could argue the trade deficit was a good thing as it drove down the prices of consumer goods but it did it at the expense of killing our wealth making businesses that employed many. Now that many of the wonderful high paying jobs of the bubble period are gone we have no base to fall back on which why Timmy’s plan is not viable or well received. Our leaders need to get serious and learn “wealth is manufactured not printed”; and by manufactured I mean production of goods not economic or statistical trickery.

As for Gold and the Dollar I have attached two charts that you can view. The charts are End Of Day prices for both gold and the Dollar index. While the current correction is difficult to stomach I thought a picture is worth a thousand words. You can clearly see the channels showing the direction and trading ranges of both. I also included the stochastic indicator which gives you a sense of oversold and overbought conditions which shows gold further in to oversold than the dollar into overbought; but both well off the extremes. Unless the Dollar violates the top trend line with sufficient vigor and gold violates the bottom trend line in the same fashion then this is just a correction in both. Please excuse the lines as I drew them free hand on a tablet.

Have a great weekend all!

Click on Gold  Chart for larger image:

Click on Dollar Chart for larger image:

Thursday, October 21, 2010

What Ya Talkin' Bout Timmy?

The title to this post paraphrases the late Gary Coleman’s famous tagline ”What ya Talkin’ ‘bout Willis?” from the show “Different Strokes”. When Gary’s character heard double speak or something perceived contradictory from Willis his brother played by Todd Bridges, he would blurt out the tagline and the camera would zoom in on his face looking perplexed. These days the general and investing public has been cast in the role of Gary Coleman’s character Arnold. I can visualize people all across this great nation of ours listening to the politicians and talking heads with the comments, theories and explanations tossed about and there must be millions of “Arnold moments” each and every day.

Just turn on the news and you can hear genius at work like Nancy Pelosi who said “Unemployment check are the fastest way to create jobs” We also have another famous Nancy quote regarding the Obamacare bill, ”We need to pass the healthcare bill to find out what's in it” “What ya talkin’ bout Nancy?”

I don’t mean to pick on poor Nancy as everyday you can hear these contradictory or inane statements from all levels of government and media and it leads one to wonder if anyone really knows what is going on. This leads me to today’s whipping boy Timmy “Turbo Tax” Geihtner who has talking out of both sides of his head yesterday.  In the first article Timmy was quoted on October 18th 201 as saying “we’re going to work very hard to make sure that we preserve confidence in the strong dollar.” Timmy was making his case for why the Chinese Yuan should rise. The following afternoon October 19th on Bloomberg an article appears titled “Geihtner Weak Dollar Seen as U.S. Recovery Route Versus BRICs”. This article flies in the face of the strong dollar argument even though Geihtner is quoted again in this article with the aforementioned strong dollar quote. This type of double speak is enough to make the market say “What ya talkin’ bout Timmy?”.  Mixed messages are nothing new in politics or the media and managing the media and the markets are part of the MOPE or management of perception economics, practiced by the Government and the FED.

Reading between the lines one realizes that both the Government and the FED want a lower Dollar and more inflation, but they want it in an orderly fashion. The pronouncements appear to me to be specifically timed and targeted to walk the dollar down in an orderly fashion. I am aware of the oversold condition in the Dollar, but it appears that if no one came out and said anything to support the dollar the oversold condition could have turned in to a waterfall decline, which would not have been good. Of course market actions sometimes defy logic in the short term as they did on Tuesday when China raised its rate .25% which you would have thought would have driven the Yuan up but market stupidity used it as an excuse to rally the Dollar from oversold.

The Dollar could have room to run but as I said yesterday I view this as a trade more than a trend. In fact today the Dollar is retreating from its over 1 point gain yesterday and the markets and precious metals are up too as we await the FED's Beige book.

In yet another "What ya talkin' bout Timmy?" moment an article appears in the Wall Street Journal titled, " Geithner's Goal: Rebalanced World Economy", which is nothing short of more posturing for the G20 meeting. To start with Timmy and company have not proven that their ideas could even rebalance the US economy let alone the world's. In the article he goes on to state that they want to set norms for currency exchange and the rationale is that it is not fair that some are overvalued and others not. Once again the command and control everything philosophy of the current Washington culture wants to spread its octopus tentacales out and ensnare the whole world. News flash Mr. Geihtner life is not fair and the reason for currencies being valued the way they are is a reflection of the underlying economy of the host country, interventions aside. He should be taking the opposite argument that currencies should not be managed at all, but instead the market will fairly value them and this would be a balancing mechanism. If a currency is over or undervalued the way to fix it is to address the basic problems in the economy not manipulate and distort the currency markets. The world is full of diverse economies and trying to manage the currencies will end up creating distortions and even larger problems, just look at the Euro zone and its problems for example. The Euro zone has rules that dictate deficits and other aspects of an economy and a managed currency over a diverse region, and you can see this resulted in the crisis we see unfolding today.

Now to be fair Geithner is not talking about a one world currency at least not yet but instead managing all currencies to be "fair". I believe this scenario will not come to pass because to do so would put each countries economic sovereignty at risk and that is a gamble that no country wants to take. In fact at the conclusion of the article, the Chinese representative had a quote concerning their trade surplus, which would fall under such a managed currency regime and it shows exactly why this will not work. ....A spokesman for the Chinese Ministry of Commerce, Yao Jian, said last week, "Other countries have no right to comment on what is a reasonable level for a country's trade surplus." There you have it no country wants to put their economic well being in the hands of bureaucrats who have only academia and think tanks to guide them. An overarching currency management system will not work unless all the participants feel it supports their own interests and economic sovereignty because giving those up is tantamount to surrendering your political sovereignty, which no leader or people for that matter would do. Would the US Government or the average US citizen want to give up the ability to manage our own fiscal house as conditions dictate or would we blindly implement orders from some commission in Paris, the Hague or Bejing?

The bottom line here is that all the buzz related to the dollar from not devaluing to re-balancing falls under the "do as I say not as I do" heading. I am more convinced then ever that we will see dollar devaluation, because as Shakespeare once penned, "The lady doth protest too much" and right now Timmy "Turbo Tax" plays the role to a tee. We have seen this we will not devalue stance play out before in other countries where the leaders have made firm statements that devaluation was out of the question, with out fail shortly there after the devaluation appears, just think back to the "Asian Tigers" in the late 1990's. The argument for investing in things versus paper gets stronger by the day.

On a separate note it seems that the mainstream press is picking up on the growing Municipal bond problem that I reported in my blog post “Municipal Jenga”. Today Forbes released an article titled “Municipal Bondholders Must Worry About Default”, which is worth a read and is a nice follow up to what I had reported.

Tuesday, October 19, 2010

Only two things are infinite, the universe and market stupidity, and I'm not sure about the former.

Demonstrating the modification of Albert Einstein’s famous quote, the markets reacted to the news of the Peoples Bank of China raising their interest rate by .25% by drubbing stocks, commodities, precious metals and just about every asset class but the Dollar. I discussed yesterday why this was illogical and is more than likely a short term technical trade that was looking for a catalyst to allow the algorithm number crunching machines to do their dirty work lining Goldman’s and Morgan’s pockets(would not want to miss out on those bonuses). This could be a case of buy the rumor and sell the news for the US Dollar, which someone once said is currently the best looking horse at the glue factory or the tallest midget your choice. We all know that the Dollar along with every other Fiat currency is flawed. The rationale explaining yesterday’s move in the Dollar was that a deal was struck with the Chinese that they would raise their rates thereby allowing the Yuan to rise and the FED would limit its QE.

I believe that this is all baloney as there were two articles appearing yesterday floating trial balloons regarding QE2. The first article release in the morning was quoting the FED’s Lockhart who in a CNBC interview stated that ‘If we're going to pursue another round of quantitative easing, it has to be a large enough number to make a difference.” "As a monthly number ($100 billion) is fairly consistent with what we did before, and so I think it would certainly be in the range of numbers one might consider ... but if you were talking about $100 billion as simply the overall program, I think that's too small," he said. So if you tabulate the figure of $100 Billion a month that is another $1.2 Trillion, hey but what is a few Trillion Dollars between friends, right?

Lockhart not a voting member of the FED board until 2012 is stating publicly the $1.2 Trillion figure while analysts are expecting a large round of easing but totaling in the $500 Billion range. I suspect that as always this is a trial balloon and depending on the data the figure will fall somewhere in between.  In follow up article to the Lockhart piece further bolsters by the statements from New York FED President William Dudley  and echoed by Chicago FED President Charles Evans both of whom in speeches suggested again that, ”some officials would like to consider explicitly raising the Fed's inflation target for a time, a controversial proposal.”

There is some dissent on the FED regarding the efficacy of the past and potentially future stimulus from Dallas FED President Richard Fisher and Minneapolis FED President Narayana Kocherlakota, however, it appears that they may be dissenting votes but not the majority opinion.  My guess is that we will get QE2 whether we want it or not as this “Helicopter Ben’s” modus operandi.

The incredible part of this whole mess is that the emerging market economies are complaining that there is a flood of capital chasing higher rates in their markets due to FED easing and the lower dollar. The response is to raise rates ...Yes that  will drive those yield seeking investors out of their markets and back in to the US Dollar. You can’t make this up!

So to add to this whole mess there is the whole bombshell that just came out regarding Pimco, The New York Federal Reserve and Bank Of America Bond Holders who are seeking to force Bank of America to buy back as much as $47 Billion in Mortgage related bonds via a demand letter. I believe that this is the first of the shoes to drop and others will follow suit. It also shines a light on the fact that the FED along with others who hold trillions in securitized mortgage debt also known as colateralized mortgage obligations or derivatives that are not suitable to be held by these institutions.  A demand letter is a legal document that states a legal claim making a demand for performance or payment of an obligation. The fact that the FED itself has file a demand letter shows the subpar quality of the underlying asset and that the bundle of mortgages are a potential legal mess. Bank of America is just the tip of the iceberg and this will in the near future cause big problems for the markets stock and real estate, the FED and the almighty Dollar. The FED is not going to eat this they will extract their pound of flesh either by ramming down the banks throat or performing a little QE for themselves.  The FED should never have taken these toxic assets if you can call them assets on to its balance sheet in the first place, because all they have done was delayed putting the system at risk. Once this multi trillion dollar fiasco begins to unwind the confidence in the FED and Dollar will be severely damaged possibly irreparably and could be the catalyst for the money capacitors to discharge.

So even though the markets acted irrationally on Tuesday the long term trends for the investment vehicles I have been mentioning have not changed, in fact once the dust settles the case should be even more compelling. None of this can end well especially since the underlying problems have not cleared up in fact they probably just added a new dimension to the problem with the unraveling of the securitized debt market which has even ensnared the FED to the tune of a couple Trillion Dollars.  For now the mainstream media will be  pumping the Dollar trade but that is all it is a trade.

Putting Lipstick On The Dollar Pig - Playing Dress Up For the G20.

The Bank of China raises its rates by .25% in a surprise move, under the guise of controlling inflation as a result of their massive stimulus.  This move by China comes on the heels of Tim “Turbo Tax” Geihtner’s jaw boning about the Yuan Dollar peg and how it needs to be adjusted. “Timmy” went further pushing the tried and true hollow sounding, "we're going to work very hard to make sure that we preserve confidence in the strong dollar." So we are back to the strong dollar policy as we continue to print dollars at a faster rate, is anyone left to buy this line?  What "Timmy" is pontificating flies in the face of the FED's pronouncements for higher inflation as a stronger dollar would fuel the opposite.  The amazing thing to me is that as a result of this tiny .25% raise it is seen as Dollar positive, as opposed to posturing prior to the upcoming G20 meeting. There are rumors(which is all they are) that the rate raise is part of a deal that was brokered where the Chinese would raise rates and allow the Yuan to strengthen if the US agrees to limit QE. This is pure speculation that is driving this; in fact just this morning the FED's Lockhart is contradicting this by stating that the FED's next QE has to be BIG.

It is blatantly obvious that China has decided to “throw the dog a bone” to avoid negative press from the G20 media blitz. I mean really, what happens to the Dow or NASDAQ when the FED raises by that amount, that’s right, virtually no reaction. To some this is viewed as a suggestion that there is going to be cooperation in the currency markets, I for one doubt it since we have seen this before…talk is cheap! We see this sort of political theater before every G20 meeting and it ultimately amounts to nothing but cover stories and deflection vehicles for those that need to avoid something uncomfortable like the Chinese and their Yuan peg.

The Yuan is pegged on the order of about 6.6 to 1 Dollar. In fact China has already allowed its currency to rise 2.7% this year, although the article claims that the upside on the Yuan is limited the factors surrounding the Yaun are dynnamic and I doubt the Chinese will sit idly by. So since relaxing the peg the Yuan has gotten more valuable while the Dollar has been the inverse.

The rate increase in China is being viewed as Dollar positive why? Oh I see it will become cheaper for the Chinese to import all the manufacturing from the US and help the Dollar and the trade deficit. Really does anyone believe that load of malarkey? If anything China raising rates should be Dollar negative. US interest rates are basically zero bound in a country with massive deficits, questions as to fiscal responsibility and solvency without printing money. The FED has telegraphed officially that they plan to implement QE2 and we can all argue as to the degree of QE that will be officially told, however, the FED is an opaque organization. The FED has been less than open as to what it actually does and reports; going as far as blocking FOIA (Freedom Of Information Act) requests and not stipulating where and to whom bailout money went. Does anyone really believe that the FED will stand by the official QE stance especially if the economy slows or there are signs at least in the FED’s mind, of deflation.

So as the old adage says money flows to where it is treated best and one could make a very compelling argument that it is being treated far better in China then under current US policy. The higher rate of interest obtainable in China should drive money to find a home there as opposed to parking it in the US at lower rates, especially given that China is a trade surplus nation. In the past it may not have even been considered an option but China of today is far different after more than a decade of economic growth. Money moving in to China seeking yield and other assets will only help to fuel China’s growth and serve to effectively starve off capital from the US. If money does flow in to China this will effectively weaken the Dollar even further and since there will be even less buyers of low rate US debt the FED will have to step in and monetize the bonds necessary to keep the government functioning. The last figure I saw was that the US currently depends on the kindness of strangers for roughly $3 Billion a day to keep the game going.

As I type this the US Government is crowding out the private sector for access to capital and is eating the golden eggs the goose produces. If the Chinese incrementally keep raising rates over a period of time and at a rate that does not impede their economy, the US Government will be forced to completely crowd out private investment in the US to fund their deficits, effectively forcing the Golden Goose to be served up on a platter. So rather than viewing the rise in rates in China as a positive I believe that while the market does not always act rationally once the news is digested and viewed in the context of longer term it will be yet another coffin nail in the Dollar. The Dollar has bounced on the heels of this news and will probably do so for the next couple days, but I do not feel that the Dollar’s sudden bounce negates the down trend that is firmly established. Sure there was an extreme in dollar bearishness that fueled this bounce, but that pessimism can turn very quickly and is probably not the best source for a new bull market in the Dollar.

If the reason for the rate increase as is stated is an increase of inflation in China then raising rates is one solution for the Chinese, but they could also allow their currency to appreciate even more than they have. A rise in the Yuan would allow the Chinese to acquire the natural resources they badly need at cheaper prices. Most of the commodities the Chinese are seeking trade around the world denominated in Dollars so by allowing the Yuan to get stronger against the dollar the price of commodities actually declines for those converting Yuan. It also appears that the Chinese have engaged in a somewhat covert move to step away from the dollar by forming agreements with specific countries to trade directly. For example a non Dollar pegged Rupee Yuan deal is sought and there were other deals recently in which China and Brazil agreed to exchanging in the Real and Yuan thus avoiding the dollar.

There are those who argue that there is no alternative to the dollar because no currency is as deep as the Dollar at the moment. I believe that there are alternatives available at present in the form of basket weighting of currencies which would provide enough liquidity, however, I do not believe that we as a world will go the basket currency route. At the moment China is still developing economically and do not have the internal markets to be self sustaining, they are still dependent on exports to keep their economic motor humming, but this is changing. If one looks at history there was a period of time where the US was a huge exporter and we had self sustaining markets; in other words while what happened elsewhere in the world may have affected us it did not cripple us; instead it was viewed the other way around. This gave rise to the saying “When the US sneezes the rest of the world catches a cold”.

The Chinese have both a culture that long range plans and a centrally planned economy. Prior to the rise of the West, for hundreds of years the Chinese were the economic superpower and they as a nation seek to return to former glory. The culture dictates that the Chinese are willing to sacrifice today to get to tomorrow and the centrally planned economy, which has become more flexible over time is their vehicle to get there. The Centrally planned economy has been far from perfect doing things like building entire cities that currently stand empty, but they do appear to learn from mistakes. There are many on this side of the pond that argue the aforementioned point as to why the Chinese will fail to grow, but is our system with a central bank and bloated government that has mis-allocated trillions any better in its current form? I personally do not believe in centrally planned economies. On the other hand if China can continue to form their sort of  hybrid of capitalism and centrally planned economy they should fare very well.

So the bottom line here is I believe that the bounce in the Dollar will dissipate after the G20 meeting since no agreements will be reached. There is also a second possibility that we see what I call a fracture in the Dollar system, where the Dollar and gold both go up as has happened in the past. This scenario would be caused by a split of people recognizing saving in gold and spending in dollars. In other words people figure out that they can protect their savings in gold and buy or transact for items in Dollars, kind of a defacto gold dollar peg.

There is no stomach on anyone’s part to endure the pains required to right the system or for those in better shape to give up anything for the common good. Additionally, it appears to me that the “recovery” is already on shaky ground which will not exactly lead to more cooperation. In the mean time I am monitoring the precious metals, commodities, suppliers and “arms dealers” for additions and entry points. We are being given another opportunity to convert those dollars in to “things”, take advantage.

Monday, October 18, 2010

What goes up may come down …then go up again…

Gold the yellow metal, king of all money, is due for a correction, after all nothing goes straight up forever, but there is no law that says any asset has to correct. The US Dollar is currently stretched to the downside after falling on the order if 11% while the yellow metal rose about 14% over the same period. Neither gold not the Dollar are over extended in the longer term standard deviation context as they are both well off their respective high extremes, however, on a short term basis they are a bit stretched. The markets, stock, bond, currency and commodity are all manic at the moment jumping from one news tidbit to the next. Rest assured dear reader that the long term trend is still intact and really nothing has changed in the outlook for the metal of kings. The 200 day moving average for gold is currently about $1,194.95while the 50 day moving average is currently $1,225.44. Over the past year when there have been corrections, gold has bottomed out at or near the 50 day moving average and I do not think that it is out of the question to see a pull back of this magnitude, which would be both normal and healthy.

The dollar and gold could continue their reversing dance until the elections in November which would also coincide with the FED meeting. The dollar is strengthening because there is a perception that the Republicans will win many seats in the houses of congress leading to a gridlock situation and putting a halt to the Obama agenda. On the one hand the perception will probably prove to be partially correct, the agenda will change but the economy will worsen again and there will be outcry to do something. Moreover, lord knows what will come out of the lame duck session since the election is over and the congress people have nothing to lose at this point so they could enact harmful legislation.

Even if the American populous believes that they have done the right thing by throwing the bums out, which I believe would be a good thing, it does nothing to control the FED. The FED has telegraphed its intention to use QE2 and if you believe that they won’t now that there is a new congress then possibly you might be interested in some swamp land in Arizona as well. The US Dollar is the world’s reserve currency at least for the moment and the result of that is the US gets to do things monetarily that other nations cannot. To explain the situation I suggest you read the article but Financial Times writer Martin Wolf entitled “Why America Will Win The Currency War”. The article explains the technicals of what is happening in the currency markets, but Wolf sums up the outcome in the following two quotes:

“To put it crudely, the US wants to inflate the rest of the world, while the latter is trying to deflate the US. The US must win, since it has infinite ammunition: there is no limit to the dollars the Federal Reserve can create. What needs to be discussed is the terms of the world’s surrender: the needed changes in nominal exchange rates and domestic policies around the world.”

“In short, US policymakers will do whatever is required to avoid deflation. Indeed, the Fed will keep going until the US is satisfactorily reflated. What that effort does to the rest of the world is not its concern.”

The FED is still deathly afraid of deflation and will do whatever it takes to prevent it. The FED is living up to the inflate or die philosophy and as I have discussed before they are ignoring the “capacitors” of inflation laying dormant around the world.

So to sum up I believe that there could be a healthy and short lived correction of 2 – 4 weeks in gold and the Dollar(Gold down dollar up). Gold could reach all the way down to its 50 day moving average although I think it will not go quite that low. The current weakness in gold is going to present a phenomenal buying opportunity in the near future as the overbought condition that I believe is becoming less relevant is relieved.

Even with the replacement of congress the FED is still acting on its own and controls the printing press. Given the FED’s bias for inflation and the fragile economy they will paper over any and all problems by devaluing the Dollar. The FED knows that devaluing will inflate away the country’s debts and fuel inflation. Another consequence over the longer term is that jobs could return to the US the currency gets cheaper against other currencies it becomes more cost effective to manufacture goods here in the US especially once the weak dollar causes fuel prices to escalate. The manufacturing sector will also be able to export since their goods will have a cost advantage priced in dollars. Overall the inflation will lower the standard of living, but at the same time will provide jobs and opportunity.

So while the November 2nd elections are driving short term prices in gold ultimately November 3rd FED meeting will rule the day. The old adage “Don’t fight the FED” should be your credo which also means that you should continue to accumulate gold, silver and commodities on pullbacks. It is very difficult to buy on pullbacks particularly when the mainstream media and Wall Street big mouths will be telling you that gold and tangibles of all kinds are dead and the run is over. You need to filter the short term noise and ask yourself “Has anything really changed to alter the story of the last 10+ years?” Every year it seems the investing community falls for the same script..the tangibles run is over and we are going back to the good old days where green shoots abound and the second half recovery is just around the corner. “Don’t fight the FED “ is good advice but “Don’t fight reality” is better.