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.

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.

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.

Ugly Ugly

Equity markets worldwide dumped 4-8%. Commodity markets dumped. Junk bonds fell 2-3%. Investment grade and sovereign bonds rose a bit. Gold skyrocketed – and then fell (probably the beginning of margin calls). The TED spread is still low at 26 bps – but rising fast. Given zero interest rates for short-term debt – the risk of a global liquidity crunch or flash crash will rise sharply if it hits 40 bps. Still however a long way from a 2008 level liquidity crunch (100-400 bps). S&P500 VIX is at 31.6 – so now in parabolic panic mode. The swissie and the dollar were the only safe havens today – and both are now in full QE mode to debase themselves.

Technically, markets are still ugly. Oversold but no indication that any tradeable bottom has been reached. The S&P500 just hit “correction” mode today (10% off peak). European markets are in full bear market mode. I really don’t see how the massive numbers of serious problems can just be dismissed/ignored by US equity investors as part of a normal “correction”. More pain is due.

On an intermediate term basis, the technicals are as ugly as I have seen since 2008. On a short-term basis, markets are heavily oversold but zero zero indication of any buyers out there. Given the selling today, any short-term bounce is likely 3+ days away. And the risk of a crash is very high. My guess is that the markets will drop until a new globally coordinated QE to debase fiat money is hinted at. Right now, the most oversold/bearish/negative sentiment sector is industrials. That could change – but if it doesn’t and there is a bounce, that is the one that will likely bounce hardest.

Asia is now dumping. Gold is steady. Rumor is that Italy had bank runs today – so unless the ECB intervenes successfully – tomorrow – the euro experiment will end by next week.

Anyone who is using leverage or who has debt or anything is about to discover how painful that is in a deleveraging deflationary cycle.

We don’t need no steenkin safe haven

Well so much for the swissie and the yen as safe havens. The Swiss National Bank just announced their version of QE in order to halt-reverse the skyrocketing appreciation of the Swiss Franc. The Bank of Japan just announced an intervention to crush the yen. Brazil and Philippines — yeesh – safe havens?!? – just announced their versions of a currency war. Bank of New York just announced that they will charge 13 bps for all large cash deposits. The 3 mo T-bill is now yielding negative interest. Italy is now on the “bailout” list — markets all now shut down — but is too large to bail out. All markets are projectile vomiting – down multiple %.

Gold is up — big — but be very careful buying here. It is a dead bang certainty that CME will raise margins real real soon in order to wash paper longs out. Why the freak don’t they just raise margins to 100% and leave them there. The whole point of gold as an alternative currency is that it is UNLEVERAGED unlike all the other leveraged fast-money speculations out there. And that it therefore does not have to suffer from occasional deleveraging bank-based fiat currencies. Forget about gold mining stocks here — the risks of nationalization and confiscatory taxes worldwide are rising in line with the gold price. Central banks are now panic buying gold — and they will have no problem confiscating gold in the ground if they can’t get gold in the market. These stupid greedy fucks running the world are driving every single fucking economy in the world into a depression. It is time to pry their hands off the levers of power — cold dead hands if necessary.

With all the developed world sovereigns in, basically, various stages of bankruptcy; we could be nearing the Kondratieff winter credit crunch of all credit crunches. Right now, bond vigilantes are only focused on Eurozone – Italy, Spain, etc. But that could change in a nanosecond. All major nation public finances are crap and none are remotely capable of growing out of their debt load. The only thing preventing the emergence of true bond vigilantes – ie investors who are concerned with not only getting paid a reasonable rate of interest but also interested in getting their principal back — is that they have no safe “base” where they can withdraw to if necessary. Currency wars and trade wars are imminent.

Debt Ceiling Assessment

The jokers in DC have, unsurprisingly, managed to ensure that “business as usual” is safe and sound – while pretending to wear the newly fashionable hairshirt of fiscal responsibility. The actual spending cuts (as opposed to crossing items off of Santa’s wish list and calling them “cuts”) in the debt ceiling deal amount to roughly $30 billion. In exchange, the American people now have an additional $2.4 TRILLION worth of perpetual debt on our shoulders. In a year and a half, we will go through this nonsense again. This is a complete fraud. In a just society, the revolution would start now and a lot of people in DC would swing from a rope. It won’t happen. Those who are the most screwed by this deal (the young) are also the ones who have the most recent experience with an education system that is good only at inculcating propaganda about how great things are.

Even Bill Gross – the bailout-loving bond vigilante who has been AWOL for a couple decades – admits it is a fraud in his weekly update – Kings of the Wild Frontier. He does provide useful advice from a bond investors perspective:

He correctly states that there are only four options that the US government has (apart from outright default which won’t ever happen):
1. Balance the budget via growth — Won’t ever happen. The debt load itself now ensures that interest rates which accompany increased growth will strangle that growth and drive deficits deeper.

2. Unexpected inflation — Nice emphasis on unexpected. IOW – TIPS are garbage — as are any and all government stats re inflation. They will lie to the bitter end about what inflation actually is.

3. Currency depreciation — I disagree with Gross here. There is only a small and dwindling group of currencies against which the US$ can really depreciate. Solid, fiscally responsible nations that issue a fiat currency. None — NONE — of them are remotely large enough to take the necessary appreciation hit. And for all the world’s bitching and moaning about the dollar as a reserve currency, not one country has ever remotely considered taking the necessary penalty (gutting one’s manufacturing/export/surplus sector in order to become consumption/demand/deficit of last resort for the world) required to have the “privilege” of being the reserve currency. At best, the “fiscally responsible” are merely the last lemming rushing toward the cliff.

4. Financial repression — Gross only mentions negative real interest rates. He is correct that this is permanent. And this is the real tailwind that will drive gold and monetizable backwardated commodities higher (in purchasing power terms – not necessarily nominal terms). When gold yields zero – and Treasuries also yield zero; it is a no-brainer as to where one should put their money. That said — Gross is missing literally thousands of other means of financial repression and thievery. Most of which are now certain to be tried.

It is critical however to understand how DEFLATIONARY these sovereign debt defaults/jitters are. Monetizable commodities will do OK — but understand the difference between a monetizable commodity and a regular commodity.

AAA Credit

What the US debt kerfuffle is revealing is an interesting end game re true AAA debt. Even if the US successfully kicks this current can down the road, US sovereign debt can no longer be considered truly AAA safe. Which raises a serious problem for the global credit markets. If US Treasuries aren’t AAA, what bond issuer on Earth IS? And what will happen to such AAA bonds if/when the US gets formally downgraded?

As to the first question, the list is teeny. The universe can only be sovereign bonds of sovereigns who have very comfortable total debt limits and who are also comfortable with their currency skyrocketing in value relative to other fiat currency issuers who may debase their currency in order to pay off debt. And companies that are both financially strong enough to merit a AAA and are also global enough to avoid getting hammered by confiscatory taxes in those countries that may confiscate their way to a balanced budget or debt reduction. Among the sovereign issuers — Australia, Denmark, Finland, Luxembourg, Norway, Sweden, and Switzerland. Followed at the true AA+ level by Netherlands, Austria, and perhaps Canada and Germany. Chile would be AAA as well except that it has no government debt. Among corporate issuers — Johnson and Johnson and KfW (a German bank). That’s it.

AAA rated bonds — accurately rated AAA — are the core of global credit markets and credit creation. Anyone who is issuing credit to anyone needs some “riskless” asset against which they can measure/rate the risks of the credit to someone riskier. Riskless bonds also serve as the collateral/reserve for, literally, the entire global economy. The countries I’ve listed above are teeny. The US’ current AAA rating – along with the UK and the core Eurozone – have provided that credit foundation for the growth in the global economy for decades. If those sovereign bonds become less than AAA, then “globalization” itself loses its foundation.

That’s the real deflation we face. Global trade/finance becomes much riskier because it is based on less-than-AAA credit. The bubbles, crashes, panics, liquidity injections (resulting in commodity inflation), etc are merely the manifestation of that riskiness. If global trade/finance instead becomes based on a smaller pool of true AAA credit (countries above plus AU), then it will shrink dramatically. And until time passes and large economies can delever and become truly AAA again; then nothing CAN fundamentally change. It is why this sort of deflationary “cycle” can last so long – think decades.

What will happen? Globally, those AAA credits (and gold – as an asset with no liability risk attached) will rise in value. They are the “last man standing” – under any and all investable scenarios and so will attract whatever credit needs a riskless foundation. The only true “sleep at night” credit. Their value is NOT going to be merely the “price” or the “income yield” of the asset. Rather, their value is that they are the only source of riskless credit/leverage. That value will not be apparent most of the time – but when it does become apparent it will become glaringly apparent. To the degree that that pool of AAA credit is simply too small to support a global economy, then investment will overflow to riskier credit – but that will be erratic and depend on news flow and such.

For more details – read Nicolai Kondratieff, Joseph Schumpeter, Irving Fisher, Hyman Minski, Melchior Palyi, Antal Fekete. This is not mainstream economics. Then again, mainstream economics has been a colossal screw up for a few years — and everyone knows it.

On edit: After close of business today, the Chicago Mercantile Exchange issued a new set of guidelines re margin collateral. Short-term Treasuries will from now on get a “haircut” (0.5%) when used as collateral. This haircut will get larger over time. Which will in turn reduce the amount of leverage that is possible and the amount of credit that is made available. It will affect margin credit, bank credit, derivatives credit, trade finance credit, everything. This particular move is small but the direction and future moves are inevitable.

June 16, 2011

Short-term: 1 green, 1 yellow, 1 red
Intermediate-term: 4 red
Composite: Bearish

A bit of a disconnect. The short-term indicators are close to an oversold condition (and possible technical support levels too) – but intermediate term indicators are deteriorating further. Given the overall news – and especially the complete absence of liquidity in the market – it will take a headline news event to create a bounce.

Something like “IMF and ECB agree on Greece debt package. Greece agrees to pretend it will pay the debt back. Banks agree to pretend that their balance sheets are solid. Everyone agrees that now is a great buying opportunity. Everyone wins. Sunny days are forecast.”

Interestingly, I cannot find the actual price of a Greek sovereign bond. All the news items are about the cost of a Greek credit default swap (currently 2189 basis points – 21.9% of the principal value of a 5 yr bond). But CDS’s are purely leveraged side-bets made by the peanut gallery of banks and other finance insiders — who have already proven that they get to keep all CDS profits while passing on all CDS losses to taxpayers.

As long as the price of an actual Greek sovereign bond remains completely hidden behind a wall of fraudulent and opaque accounting, then the Greek people themselves are unable to decide whether the costs of sovereign default (inability for their govt to run deficits for years, dropping out of the euro, etc) outweigh the benefits (reduction of the debt principal and future tax payments). In theory, and historically, there is another cost of sovereign default to foreign creditors — and that is war – as those creditors may try to forcibly take what is owed to them. But denying that information to the Greek people themselves means that the Greek government has already allied with foreign banks against its own people and the Greek people are no longer sovereign. Their government is no longer responsible to them.

While the particulars of what is happening in Europe are unique to their disastrous euro experiment; some of the core sovereignty issue applies to the US and other governments as well. Governments are increasingly going to become allied to the global multilateral institutions themselves and any practical notion of “government is by the consent of the governed – by a social contract” will simply vanish. And I seriously don’t think it will be challenged. We are far more addicted to the globalized mess of pottage than to the freedom/responsibility of self-governance.