Weekend Update

Equity markets: My long-side trade earlier this week failed because it was one day early and I didn’t have the stomach for the downside volatility which was the first move. Short-term, equity markets are still neutral – with a slight upward bias absent headline news. That “absence of news” could last for the rest of the summer. But the volatility is going to remain. Equities are still not pricing in an economic slowdown – much less another deleveraging/crisis cycle. But they are heavily oversold. That said – half of the “oversold”ness has already been corrected – simply by going nowhere for a few days. So any new equity investment has to lean bullish rather than simply leaning towards an oversold scalp. And intermediate-term – I am more bearish than I was this time last week.

Credit markets: Like last week, these are the key markets. But these generally deteriorated a bit this week. In Europe, Italy/Spain yields fell (presumably because of ECB buying) while Germany/France yields rose. Interbank/overnight/TED spreads are still widening – but are not a problem yet. The ECB may have succeeded in buying a bit of time – but at the cost of directly revealing to Germans what the cost is going to be for them. Ultimately, any credit crisis from Europe is going to be indicated by a)debt auction timing from the four key eurozone sovereigns, b)spreads between the four, c)a banking collapse because of those spreads, and d)indications from Germany as to which way they (the taxpayers not the govt) are leaning re a longer-term fix. I suspect fiscal/transfer union may become the ultimate fix here but that is gonna be a tough sell to Germans who don’t work in banking/exports.

In the US, riskier credit bounced a bit. But the financial sector did not and the first post-AAA 30 year Treasury auction did not go well. And none of it has priced in another deleveraging/default cycle. Treasury funding could become a problem – but the bad news cycle on that is almost certainly over for a few months.

Currencies: The downgrade last week did not affect the dollar as much as it could have. The swissie was the worst performing currency after they intervened. So much for a post-downgrade safe haven. Followed by the two commodity currencies (C$ and A$). Gold was the best performer followed by the yen. The dollar and euro are now lashed together via swap lines. The safe haven trade is still the operative one which doesn’t bode well for equities or commodities. And since the dollar is not going to be downgraded again this week – and since gold/yen are, like the swissie, at/near their breaking points for intervention – I expect the dollar/euro links to weaken a bit and for the dollar to resume its role as safe haven. There simply is no alternative right now and until there is one – the dollar is both the reserve currency and the safe haven currency. Period.

Precious metals: All four performed better than currencies – in order gold (because of the gap up over last weekend), platinum, then a gap to silver, palladium. Going forward, I think the forces that are driving them and the price volatility that results are going to provide for good trades. Longer-term, they will all outperform currencies so offer good risk-reward v cash. Cash however still has the optionality value. All will get some safe haven demand. Gold/silver are the two most vulnerable to deleveraging in the very crowded Western “paper precious” market – and that WILL create big fast price swings. Silver/palladium are the two most vulnerable to poor economic outlooks. Gold/platinum have the lowest-risk downside – but gold’s potential downside is $300 lower than platinum’s – and both will likely respond first to whatever the central bank “trickle-down” (aka QE/bailout) response is to this deflation run. Platinum/palladium have the best response to either short-term supply shocks (S Africa strikes) or longer-term physical supply/demand bottlenecks. In a word – there is opportunity here, and if one is wrong about the shorter-term trade then its ok because the longer-term picture is good. But this applies mainly to the metal/physical itself — not to the miners or options or futures or ETF’s or anything else.


Aug 11, 2011

American and Asian markets want to bottom in here. Europe is the problem. Gold is dropping after CME hiked margins. Expect more of that as long as gold gets the attention as a safe haven. The SNB has announced its version of QE which makes short-term interest rates negative and which will hit margined currency traders the hardest. It has denied rumors that it might peg the swissie to the euro — but that might just be a trial balloon. The recognized “safe havens” are now extracting a very high price/risk for that “safety”. Unrecognized safe havens — pound, krona, platinum – are far better IMO. Once those “fill up”, then the world is gonna have to deal with the reality that the dollar is the only safe haven large enough to have big wide open doors. Course it won’t stop them whining and bitching and moaning about Fed policy or America.

The S&P is at a real crossroads at 1120. This is the 50% line of the entire 2007-2008 bear market. Below this, people may wake up to realize that the entire rally from the 2009 lows is merely a really long bear market rally with brutal downside ahead. If it holds and rallies here, then people can see the rally as something separate from the preceding bear market. 50% is an artificial number – kind of like the Fibonnaci numbers – but symbolically it matters. And symbols matter to chartists/technicians. Also, the US market has basically completly eliminated the post-QE rally. This is a HUGE vote of non-confidence in Fed policy.
Finally, we are, basically, right back where we were last summer when Europe had the first round of crises. So this is a HUGE vote of non-confidence in ECB policy.

Short-term, I am now neutral. The broader markets will be gut-wrenchingly volatile but go nowhere. Big fundamental issues need resolving and that resolution will point the way for the market. The stock market is supposedly a discounting and anticipatory mechanism. I’m not sure I believe that anymore with computer algorithms completely dominating all trading activity. Those algorithms are not programmed to anticipate anything more than 6 nanoseconds into the future.

Right now, until that resolution, it may actually be the time for individual ideas that de-correlate from the broader markets.

Equity trade failed

Markets are still completely unable to price anything. They are holding at the lows of the last three days – but today the Euro crisis has spread to France. Societe Generale has fallen 20% today. Too much downside risk. Something has to resolve itself – or explode cathartically – in Europe before any rational human buyer steps in. And the real downside risk of a Societe Generale collapse is a 1931 CreditAnstalt.

Gold is the immediate beneficiary of this. I still prefer platinum though. If Europe does explode, the CME will eliminate all margin for gold – and all the speculators will either have to ante up the full $180,000 per contract or sell. Add to that – even if Europe merely continues to hemorrhage, margin calls and hedge fund redemptions are gonna be a real problem.

Aug 9, 2011

Wild market today again. Equities opened gap up 100 and stayed flat until the FOMC statement – immediately plunged 300 – and then reversed on a dime and up 600. Treasuries of all durations rose dramatically at the FOMC statement. So what happened?

FOMC announced that interest rates will be zero until June 2013 and that they will find ways to manipulate the entire yield curve. If you’re unemployed, you’re screwed. If you’re on a fixed income or regular paycheck work, you’re gonna get squeezed by food and energy prices. But if you’re rich and levered to the gills and have access to Uncle Ben’s casino, you just hit the jackpot. Ben just gave them two years to find the exit and corner the market in key resources.

In July 2013, with lots of additional debt – and most probably a different safe haven than the dollar; the US will experience the currency crisis of the millennium. Why was June 2013 picked? To take monetary policy beyond the 2012 election so that the election is not about monetary/debt policy but about jobs. IOW – with the debt ceiling and monetary policy the can has, presumably, been kicked far enough away so that the issues/impact fade from memory. People will be surprised and confused when 2013 hits – and will listen to the recommendations of the people who kicked the can there. Rather than hanging them from a tree. Unless Europe blows up.

The initial plunge was because the Fed stated the obvious – the economy sucks and it will for the remainder of our lives. The hopped up rocket ride after what is called a face-ripping rally. Some short-covering combined with bond money being reallocated to stocks now that Treasuries have the same yield as – oh – Apple. Or for that matter, a bar of gold.

Going forward, equity markets are probably good for a short-term ride. No one really cares that none of it works as publicly intended. The point is, it does work to keep those in control in control. As long as Toto is crippled, the Wizards can sell any old bucket of spit as the Fountain of Youth. I’m sure they will be able to blow up a stock bubble to get Joe Stupid into the market when it peaks. Or they think they can. Possibly saves the Facebook IPO – unless Facebook does a Super bowl ad with a sock puppet.

But the real action will be figuring out which assets are the targets of control in that early 2013 timeframe. Probably precious metals.

And Europe is still a huge disaster looming. I’m pretty sure they can’t kick the can until 2013. Their big “next crisis” is in two weeks – with a tranche of Greek debt due and the possibility that German taxpayers wake up to what they are being forced to fund.

Aug 8, 2011

Equity markets tanked 5-8%. Bank of America fell 20%. Basically, everything was down except gold bullion and – wait for it – Treasuries. re the latter, the dollar was down v the swissie, yen, pound, swedish krona — up v others. So my second-tier safe-havens may work here. My concern re all the non-Treasury “safe havens” is that they attract an absolute flood of panicky hot money – and then capsize. My concern re gold is purely short-term. It’s a crowded trade right now and the powers that be know how to shake that tree if they want to — and they will want to at some point soon. Plus, I’m already at full allocation and anything more is a speculation and I’m not interested in speculation right now. Even closed out the one small short I had. I like the optionality of cash. 52 wk lows are at levels only seen on a couple of days in 2008 so I think we are very near a (temporary) bottom. That said, the indicators still show absolutely nothing reversing/bottoming. In fact, they are still indicating deterioration – from extremely deteriorated levels.

Debt – like water – flows downhill

S&P is busy today announcing downgrades of businesses that either have heavy Treasury exposure or guarantees. Not a pretty day for a lot of munis and financials. Bank of America is plunging. Presumably the weakling of the big money center banks – and the guarantee of “too big too fail” is weaker now. But I wanted to focus on the negative credit watch that S&P placed on Berkshire Hathaway. Of course Moody’s won’t do the same — because Berkshire is the largest shareholder of Moodys.

I’ve read all of Warren Buffett’s shareholder letters over the years. And up to two years ago, I’ve had an enormous respect for him as one of the few CEO’s who wasn’t out to rob shareholders and who was candid (and rich) enough to be honest about a lot of things and damn the consequences. That all changed with his behavior in 2008 which was appallingly piggish and self-serving and dishonest and hypocritical. And his business partner – Charlie Munger – was repugnant (and honest) enough late last year to tell a crowd of future sharks that the bailout of billionaires (of which he/Buffett personally received benefits in the billions of dollars) was completely necessary – but that everyone who lost their jobs/savings/income because of that bailout should just “Suck it up”.

Well Charlie — Suck this. I hope you lose everything.

G7 and ECB Intervention

Not a surprise.

The ECB announced on Sunday that they would buy Spanish and Italian and other periphery bonds. The hope being that Asia will help bail out European banks which hold that debt. Kick the can. Kick the can.

The G7 Finance Ministers and Central Bank Governors also met over the weekend and released a statement before the Asia open.

We are committed to addressing the tensions stemming from the current challenges on our fiscal deficits, debt and growth, and welcome the decisive actions taken in the US and Europe. The US has adopted reforms that will deliver substantial deficit reduction over the medium term. In Europe, the Euro area Summit decided on July 21 a comprehensive package to tackle the situation in Greece and other countries facing financial tensions, notably through the flexibilisation of the EFSF. Translation — FU S&P. You are all now criminals with international arrest warrants charged with peeing in the punchbowl.

No change in fundamentals warrants the recent financial tensions faced by Spain and Italy. Translation — WTF do you people think you are? We have told you what to think for decades. And now you are disobeying us?

We welcome the additional policy measures announced by Italy and Spain to strengthen fiscal discipline and underpin the recovery in economic activity and job creation. The Euro Area Leaders have stated clearly that the involvement of the private sector in Greece is an extraordinary measure due to unique circumstances that will not be applied to any other member states of the euro area. Translation — The water is safe for you private investors to buy non-Greek debt. You won’t get screwed. We promise. Scout’s honor.

We reaffirmed our shared interest in a strong and stable international financial system, and our support for market-determined exchange rates. Excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. Translation — We are making plans to centrally-plan currency interventions while uttering soothing words about market-determined exchange rates. When the centrally-planned intervention doesn’t work, we will blame it on the disorderly market since we told you all to behave but you aren’t listening and obeying.

Weekend Update – part2

Now for indicators:

Equity markets:
Short-term – Slightly bearish
Intermediate-term – Very bearish

Markets may be extremely oversold – as in historically oversold – but show no indication of a bottom yet. The tiny number of individual equities that are showing early signs of reversal/strength are – exclusively – either the bearish ETF’s (where technical analysis generally doesn’t work because it triggers too late), bond/safe haven proxy ETF’s, or penny stocks. Sidelines for me.

Credit/bond markets:
Are showing early signs of stress. Riskier, lower priority, and longer-term are being sold relative to higher rated, short-term, or higher priority. Not signs of stability or bottoming or EOTWAWKI priced in. Credit is a leading indicator. This is not a correction for equities. Credit is where the first buy opportunities will pop up. In particular, this is where to get out of the dollar after the current dollar-inflow panic stabilizes/subsides.

International equities:
Nothing looks good here. On an intermediate-term basis though, this is where to focus equity buying when this panic runs its course.

Precious Metals:
Gold is looking OK here. That said, I suspect that going forward, it is too late to buy/add for short-term play here. Safe-haven demand is likely to be met/exceeded by ETF holdings sold to meet margin calls elsewhere. India is not going to be the physical demand savior at these prices. Silver is looking bearish. The inflation play is dead for now. And the SLV ETF is far too crowded with day-traders and speculators. Platinum is looking VERY good. Chinese are buying it hand-over-fist – for jewelry and long-term physical investment – now that platinum is roughly the same price as gold. The platinum/gold ratio of 1:1 is now where it was in the depths of 2008 and before that in the 1990’s (when China was far poorer). At these prices, auto industry demand does not matter. If platinum takes 5% of the gold jewelry market, that will equal auto industry demand. So, the most likely scenario is that it tracks gold for the short-term with far better upside/downside risk when things settle down. Palladium will follow platinum but with a bit more short-term downside risk and a bit more long-term upside.

Fuhgeddaboutit. Agriculturals are the best buy here and there is no hurry. Metals and oil are hugely subject to dishoarding of stockpiles – ie what was demand over the last 2 years can turn around in an instant and become supply.

Uggh. The swissie is the only major safe-haven currency that has not successfully debased. It is extremely overbought and Europe is clearly panicking into it. But the SNB has just announced its version of QE so as/if either the panic subsides or peaks, the swissie will plummet. Shorter-term, at current levels, the swissie is riskier than the dollar. I think the price is now too high for “recognized safe-havenness”. Way too early for commodity currencies – but a mix of second-tier “safe havens” – pound? swedish krone?

Weekend Update

A huge “newsy” week last week helped throw global markets into a serious tailspin. The two biggest are questions re what the ECB can do re Italy and the debt ceiling and downgrade kerfuffle for the US. The latter in fact exacerbates the problems of the former since it throws a risk premia spotlight on France and UK (the two weakest remaining AAA sovereign).

Impact of the Downgrade — Dead on analysis. The downgrade will exacerbate political schisms in the US as both sides will choose to blame the other (or shoot the S&P messenger) instead of dealing with the problem. The downgrade has more impact on European/global financials than it does on US financials because of the dollar’s reserve status. Trade ideas (assuming no major coordinated PR/actual move by ECB/G7): Long safe havens (Gold, CHF, global big-caps with rock-solid balance sheets and dividends) — this current decline is the last decline for awhile where the dollar will be a safe haven compared to most – you do not want to be in dollars when it ends; long Treasuries (shorter-term) and Euro-periphery debt (on yield spikes). Short euro, short “infrastructure”/commodities (coal, steel, shipping, copper, A$), short bunds, short financials.

Case for Going Global – Stronger than Ever Another dead on (longer term) analysis with a couple aha’s! for me. G7 govt bonds are pricing in slow/no growth; “emerging” govt bonds are pricing in 6-9% growth. ie – G7 is expensive, EM is cheap — on pure yield/price. EM’s have 2x more foreign exchange reserves than the entire G7 combined – and far lower govt debt. EM’s are undercapitalized (aha! – inflation there is more a consequence of “hot money” inflows relative to a small existing capital stock – iow – their inflationary pressures will drop as their GDP grows). G7 countries are all in for decades of deflationary pressure and capital exodus. EM equity markets still have lower PE’s – so they are pricing in slow growth. Trade flows are increasingly among EM’s themselves – and that will accelerate. Big disconnect/opportunity. Volatility is here to stay – because capital productivity increases (which precede GDP increases) in EM’s won’t be smooth and because G7 relative decline will also be herky-jerky. Trades: Long EM bonds, short G7 bonds. Long capital surplus countries (mostly Asia). Long commodities. Long EM equities – esp mass consumer and infrastructure – not traditional exporters. Long/watch solid financials focused on allocating capital to EM’s — ie with no legacy balance sheet in G7.

That latter link is intermediate-term. Shorter-term, the trade is still risk-off – and for EM’s that can mean “hot money inflows” turn on a dime into “hot money outflows”. But these are the opportunities to buy the dip.

My own thoughts. Any conflict between “hyperinflationists” and “deflationists” is over for awhile. The hyperinflation scenario is dead. Deflationists have won. Non-G7 will be dealing with inflationary surges – but those pressures will diminish over time. G-7 is solidly in deflation — until such time as existing debt is repudiated. Which is emphatically NOT happening any time soon. Yes – prices of non-asset “stuff” will increase in G7 and squeeze the snot out of consumers (esp the poor and the middle class and the young). But that is NOT hyperinflation or money printing.

US downgraded to AA

Well it looks like S&P is the ratings agency with courage. After the close, they downgraded US Treasury debt to AA+ with a negative outlook. The US has been rated AAA since 1917 when credit rating first started. Assuming they don’t get arrested on charges of terrorism or something, I expect that a few other AAA sovereigns may soon follow. I don’t actually expect this to cause problems but who knows. One thing it does do is slightly raise the risk and volatility of everything going forward. All financial algorithms rely on a “risk-free” rate at their core – and that is what the US Treasury market has functioned as for the last 30 years – ever since financial algorithms crossed from academia to Wall Street. That risk-free rate is now, absolutely, a little bit riskier than it was yesterday. At the margins, that could really explode some highly leveraged multi-gazillion derivatives market. It will certainly serve as a slight incentive to deleverage. It could also cause some substantive problems at some money market funds. That said, it is only long-term debt that is now rated as AA – and I suspect short-term debt is at the core of derivatives and algorithms. Here are S&P’s comments.

The political brinksmanship of recent months highlights what we see as America’s governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year’s wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability.

Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden in a manner consistent with a ‘AAA’ rating and with ‘AAA’ rated sovereign peers (see Sovereign Government Rating Methodology and Assumptions,” June 30, 2011, especially Paragraphs 36-41). In our view, the difficulty in framing a consensus on fiscal policy weakens the government’s ability to manage public finances and diverts attention from the debate over how to achieve more balanced and dynamic economic growth in an era of fiscal stringency and private-sector deleveraging (ibid). A new political consensus might (or might not) emerge after the 2012 elections, but we believe that by then, the government debt burden will likely be higher, the needed medium-term fiscal adjustment potentially greater, and the inflection point on the U.S. population’s demographics and other age-related spending drivers closer at hand (see “Global Aging 2011: In The U.S., Going Gray Will Likely Cost Even More Green, Now,” June 21, 2011).

Standard & Poor’s takes no position on the mix of spending and revenue measures that Congress and the Administration might conclude is appropriate for putting the U.S.’s finances on a sustainable footing.

This news does explain the markets today. The ratings agencies always leak the news of sovereign downgrades to the government. And our wholesome public servants at Treasury quite obviously feathered their own nests and provided inside information to their Wall Street buddies. Yet another reason why the time has probably now passed for peaceful change.