The Land of Personal Accountability & Ultimate Opportunity

The United States has always sought to balance the opportunity of the individual to achieve unbelievable success while promising a minimum safety net for us all. This leads to a society with billionaire twenty-somethings and millions scrambling to get by. I am not a politician but, if I were, I’d do everything I could to capture the vote of the millions scrambling to get by rather than the few who have risen to the top. After all, time and votes are the only things we all share equally.

This election is turning into an argument about Warren Buffet having a higher effective tax rate than his secretary. This election should be focused on the empowerment of the people in the gap between middle income and the poverty level. Every time the tax rate argument is brought up, it’s in the context of, “How can we make Mr. Buffet pay more.” I’ve yet to hear, “How can we incentivize Mr. Buffet’s secretary to create more personal wealth for herself.”  Warren Buffet has created his wealth through the ownership of a company he started. He’s very good at what he does. Our country embraces excellent performance of any kind.

The fact that President Obama has called out Mitt Romney’s creation of personal wealth is a bit hypocritical considering his American Recovery and Reinvestment Act (Jobs Act), contained a provision for a one year amnesty on 100% of capital gains based on businesses started or, acquired from September of 2010 through January of 2012. According to the IRS the top 400 reported incomes earned at least $77 million dollars and nearly 46% of their incomes came through capital gains (ownership). The downside to this is that working for wages, investing in bonds or buying dividend stocks leaves you little chance of cracking that top 1%.

Cracking the top 1% isn’t something that many of us aspire to. Our, “Pie in the sky” turns to, “Food on the table. “ The truth is many people are having an awfully tough time just putting food on the table. This year’s drought is sure to raise staple food prices by at least 15% over the next year. In fact, food inflation may be the only thing holding our economy above deflation. Meanwhile, the Associated Press recently compared the current level of poverty to where we were in 1965. Low to middle earners are getting squeezed by having to support more in government assistance programs as we reach unprecedented levels of government spending while hitting the proverbial earnings glass ceiling due to the tidal shift in American employment opportunities.

We, as a country are shifting to a new model of employment and compensation whether we like it or not. We will be increasingly compensated for our individual performance rather than as a group of employees. Union membership has declined by approximately 35% over the last thirty years to less than 8% of the workforce. Here is where the argument for the Oval Office needs to focus. The balance of power always swings from one extreme to the next.

The Industrial Revolution through WWII created too much wealth for too few at the human expense of too many. The Civil Rights movement and Lyndon Johnson’s War on Poverty provided the inflexion point to get the pendulum started back towards the working public’s favor. We are now paying the Piper for the excessive swing of the pendulum due to the hubris of our entire nation. The promises made 20 years ago by domestic manufacturers to union members simply can’t be kept if the businesses are to remain solvent. This is what Greece, Spain, Italy and France are coping with on a national level now. This is also what burst the auto industry in 2008 and most likely, the European Union in 2013. At what point can the employer and the employee agree on compensation?

There are two primary points to look at going forward. The first is ideological. Can we quantify how much individual top end we’re willing to give up to shore up the bottom end of many? Currently, we arbitrarily institute a tax rate based on income, which will always create loopholes and cheats. The higher the tax, the more it will decrease the incentive for business owners and corporations. One caveat; remember that 40% of all new jobs come from startups. Therefore, maximum reward for taking the financial risk of starting a new firm must be sufficiently rewarding. After all, no one wants to give up his or her hard earned dollars for something they’ve created from nothing.

We could also institute a Value Added Tax (VAT). This tax is based on consumption and applied to an individual’s spending. It would be applied at the Federal level and paid on everything from soft drinks to legal counseling. High-income people would face the brunt of this tax as their incomes get spent on more high dollar items. Think in terms of imported automobiles, country club dues and professional services. This would work out to a percentage-based tax paid by those who have more, spending more. Those who spend more, pay more.

The second point is one of personal accountability. The manufacturing jobs are not coming back to the U.S. in their previous form. There are simply too many expenses associated with hiring American workers relative to the added value they bring to mundane tasks. There are however, great opportunities to sell our skilled workforce at attractive rates to European Union manufacturers dealing with 30 hour work weeks, socialized health care and full retirement packages at 60 years old, regardless of profession. However, Generation Y and the Millennials must be able to demonstrate their intellectual proficiency. This must also be supported by government stimulus spent rebuilding our infrastructure to move goods to market.  This would also create domestic, value added jobs as the economy heals.

The housing bubble, the economic collapse and the Federal deficit can all be traced back to wanting more than we can afford. The U.S. may have the lowest personal savings rate of any developed economy. Unfortunately, not everyone can own a house, an iPhone and a big screen TV. Somewhere along the lines we as the general public began buying what the ad agencies were selling. Whether it was a new phone, a new car or, a new President we all bought into the pitch and that pitch has always been, “Buy now. Pay later.” Our personal savings rate peaked at 8.3% in May of 2008, its highest level since January of 1987, as the stock market took a swan dive. It’s time to square the ledger. Invest more. Spend less. Instead of arguing at the extremes of all or nothing, let’s take an honest look at the middle and try and budge that needle back into the black, for our families, our country and us as individuals.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Capital Preservation is King

Top down disasters in the financial markets take on many forms. Long Term Capital Management nearly brought down the financial system in 1998. We watched Lehman Brothers fail because the government didn’t think they were worth saving. We saw AIG fail due to the strategies it employed in the subprime housing markets. MF Global failed because the CEO tried to turn a brokerage firm into an investment-banking firm through one all in bet on the Euro Zone bailout. These were firm related disasters. We’ve also seen rogue traders bring down financial firms due to lack of oversight like Barings Bank in 1997 or, Lloyds of London in 2009.

These were all publicly owned companies, either through direct share purchases or, in the case of Long Term Capital Management, a hedge fund founded by some of the brightest minds in the industry. Publicly owned companies have multiple levels of oversight and audits to regularly submit so the governing bodies in their fields can protect the interest of the public investor.  The investing public must rely on the given agencies that we pay for through our tax dollars to provide an adequate accounting and system of checks and balances to thoroughly scrutinize their quarterly reports. We have every right to the expectation that the agencies are performing their due diligence for our sake. Privately owned firms are not subject to the full gamut of oversight. As a private company, I comply with annual audits by our governing agencies, the Commodity Futures Trading Commission (CFTC) and the National Futures Association (NFA). I am required to self report our annual questionnaire and our annual update. The recent issues at Peregrine Financial Group (PFG), is simply the implosion of a 20 year con job by someone who used the respect he had fraudulently gained to perpetuate that same fraud into the future.

Beginning in 1993, Russell Wasendorf Sr. chose to fudge his financial report to the NFA to meet the minimum capital requirement for the accounts held by his firm. He claimed that this was due to a witch hunt put in place by the governing body of the futures industry and he was forced into one of two unpalatable personal choices. He could cut his overhead and use operating revenues to rebuild his minimum capital requirement or, he could lie to regulators and maintain normal operations.

His choice was self-admittedly driven by ego. Rather than accepting the rules and making necessary cuts, he fudged the numbers and worst of all, found out he could get away with it. This allowed him to continue ignoring standard business practices of profit and loss, expansion and contraction by fudging the numbers to boost operating revenue. The boost in operating revenue led to the construction of a top shelf office building in 2009, a private jet and other luxuries that could not be afforded on actual operating revenues.

Our firm was fortunate not to have been caught up in this mess. We had been exploring deals with a new Futures Commission Merchant all spring and in some areas PFG had the best available options. We ended up with Straits Financial. I have known the Chief Operating Officer of Straits for more than 20 years. He was the head risk manager throughout my time in Chicago and taught me an awful lot about transparency. He brought that same philosophy to Straits. The clincher was the monthly public accounting of all customer funds and locations of those funds BEFORE the MF Global debacle became a story. It’s simply the right way to do business.

Futures trading is risky. So is trading stocks, bonds or real estate. We’ve been in the business long enough to know that your money is safe when you call for it and it gets deposited in your bank account. Paper is simply paper. To that end, I frequently suggest that customers only keep enough capital in their accounts to allow them to trade effectively. Removing excess capital also keeps a trader’s risk tolerances in check. This is exactly what we told the Wall Street Journal when we spoke to them on July 17th. I do the same things for customer accounts that I do for my own. On Transparency is key and personal cash in your personal account is King. We preach and preach that the only way to get ahead in the next 10 years is through the active management of your own capital. In this era of constantly changing rules and precedents, we must protect capital from trading, regulatory or, corporate malfeasance.  Trade efficiently. Trade humbly. Sleep well.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Cheap Beef Isn’t Always a Positive

The drought of 2012 now covers more than half of the continental United States. Temperatures have set records throughout 2012 leading to the warmest 12-month period since the National Oceanic and Atmospheric Administration (NOAA) began keeping records in 1895. When we combine these temperatures with the 10th driest June on record and consider that the rain we have seen has not made it to the Great Plains, it’s no wonder that grain prices have increased by 50% in the last month. Grain farmers are at least partially compensated for their lower output by higher prices on delivery as well as various insurance programs that kick in when output falls to pre-determined levels. The cattle industry faces an entirely different dilemma.

The price for beef and dairy in the U.S. changes very little at the grocery store. The competition between grocers as well as the availability of substitute goods to the shoppers make the livestock industry hold prices steady at the end point while withstanding the expense of higher feed costs on the front end. Their business plan is based on the two-year production cycle of cattle for beef, which places them in the position of absorbing losses this year while hoping to refill their coffers at higher prices two years down the road. How long can they afford to hold on to inventory while maintaining back stock for the coming year?

The cattle for beef industry is a two-step process. Individual farmers breed and raise cattle until they reach about 700lbs. These animals are then sent to feedlots to be fattened up for slaughter. Feeder cattle will nearly double in size for slaughter, ending up around 1,300lbs. The farmers and feedlots are in competition with each other. When feed costs are low, the feedlot operators can afford to fatten up the skinniest of animals. However, when costs are as high as they are now, feedlots are looking for heavier animals that have spent more time at the farms grazing. Iowa State published a paper two years ago on feed costs and determined that it takes 3,360 pounds of corn to increase fed cattle’s weight by 500lbs. This is the equivalent of 60 bushels of corn or, $420 per animal at today’s prices.

The upward pressure of grain prices forces farmers to determine how many cattle they can hold back and afford to feed versus how many they have to sell to generate more revenue to cover the higher input costs. These decisions show up in the World Agriculture Board’s forecast for greater cattle production through this fall. We will see cattle prices fall as a result of this through Halloween. The catch is that there will be fewer animals available next year and this will lead to competition among feedlots for placements because lower grain prices will increase feedlot operator margins as they finish the animals to send to the packinghouses.

These market forces will also show up in the dairy market. The relationship between feed costs and milk production are almost 1 to 1. It takes about 100lbs of feed made up of 75% corn and 25% soybean meal to produce 100lbs of milk. This equals input feed costs of $1.28 per gallon. Dairy farmers will be forced to cull their less productive cows to feed the animals that are producing well. This will add more beef cattle to the supply chain further depressing prices through this fall.

One of the best ways to determine if something is, “going on” in a market is by noticing when market relationships are out of kilter. Cattle and grains typically have a positive correlation. They tend to move in tandem. Moderately increase the price of corn and the cattle will follow suit. The opposite is also true as the cost of feed declines, so does the cost of production. However, when this relationship breaks down it’s because one market can’t keep pace or, pass on the costs of the other. That is exactly what we’re seeing between cattle and corn. The price of feed has exceeded the livestock market’s ability to pass on the costs. This brings more animals to slaughter now and will leave us with a smaller breeding herd heading into next year.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Protect Yourself from Coming Equity Declines

The stock market has been exceptionally volatile lately. The S&P 500 fell by 10.5% in the month of May only to rebound by 9% through Independence Day. The choppy market action is indicative of the bear market we are in. We have suggested that the developing economies of Brazil, Russia, India and China (BRIC’s) would help pull us through as they develop their own middle class consumers and shift towards greater domestic consumption. Furthermore, we suggested that the zero interest rate policies and Quantitative Easing 1, 2 and possibly 3 combined with Operation Twist 1 and 2 would all have the cumulative effect of devaluing the U.S. Dollar on the global market. The lower Dollar would make U.S. products cheaper on the open market and therefore, more appealing to the developing consumer class of the BRIC countries thus, boosting our exports and reviving our employment and Gross Domestic Product pictures. Unfortunately, it appears that the BRIC’s won’t be able to rescue us from a projected fourth quarter recession, which makes June’s stock market rally a great opportunity to hedge part of an equity portfolio and provide some protection ahead of a global economic downturn.

Many analysts have noted the weakness in the jobs recovery coming out of the last recession. Real incomes are actually lower than they were in ’09. Politicians may be beating the drum of the declining unemployment rate but the flip side is that we’re handing out more subsidies than ever and the budget deficit is continuing to increase. Bottom line, we’ve made no economic progress since approximately 2006 when the home refinancing boom really started to pump the asset markets full of cheap money.

The pendulum must swing both ways. There is a penalty to pay for years of excess spending. That penalty will be paid in forced thriftiness handed out by declining pensions, higher taxes, lower yields and declining equities. There is simply no way that economic promises made in the past can be kept in the future. Taxes can be measured many ways. Directly, through Uncle Sam or, indirectly through higher fuel, food and insurance costs. Yields on retirement portfolios will continue decline as the global race to devalue domestic currencies to spur export growth continues as evidenced by the European Central Bank cutting rates this week. Finally, the equity markets have not reverted to normal P/E ratios typical of a bear market bottom and are certainly not low enough to suggest the beginning of a new bull run.

The final nail in the coffin is the drawn out process of the Eurozone default, which has placed the world’s two largest economic blocks on the verge of recession/depression. This has caused the traditional BRIC economies, which are culturally based on savings to tighten their belts and prepare for the worst. This is the exact opposite approach that we took here in the U.S. post 9/11. The collapse in the equity markets spurred the Federal Reserve to pump the economy full of cheap money. This policy hasn’t changed since. Rather than allowing the U.S. to retrench and refocus on the importance of solvency, policy focused on putting smiles on the peoples’ faces after the crisis. Politicians love smiling voters and the money faucet continued to flow.

Protect yourself from the decline in the equity markets that the world’s economies and commercial traders are forecasting. The JP Morgan Global Purchasing Managers Index fell to its lowest level since 2009. This is based on more than 10,000 global businesses in more than 20 countries. Christine Lagarde, head of the International Monetary Fund is expected to cut their global growth expectations next week. Marc Faber of CNBC and Robert Wiedemer, author of, “Aftershock,” based on the post economic collapse as well as Dennis Gartman who specializes in commodity based raw materials all see a significant slowdown immediately ahead.

Finally, commercial traders in the stock index markets have been selling the June rally with reckless abandon. Their net position in the S&P 500 has declined by more than 17% in the last month. The move in the Nasdaq has been even more significant as commercial traders have trimmed their positions by more than half in just the last two weeks. The net result is that we must actively manage our own individual futures as the herd is taught to smile on its way to the packinghouse.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.