This has been a tremendously active week with big volatility and important market turns. We have to begin with last week’s gold platinum spread. We outlined the case in our Gold, Silver, Platinum and Copper Outlook. This week, April platinum traded down to nearly a $50 per ounce discount to April gold. Currently, this spread has rebounded to approximately a $5 discount. That’s as much as $4,500 profit depending on the entry point.
The equity markets have just been rip roaring strong. Companies like FedEx, Google, Morgan Stanley, Walt Disney and Boeing have all gained more than 40% this year. The equity markets have made new all time highs, eclipsing the pre-crash highs from 2007 with hardly a shudder and soldiering on past the tech bubble highs of 2000. Recently, the technical analysts at Merrill Lynch came up with a four-year target of 2300 in the S&P 500. This is based on their analysis of the long-term pattern that was triggered by the new highs. The S&P 500 has climbed more than 150% since March of 2009. While I’m the first to admit that I’ve left a lot of money on the table by not sticking with the long side of equities, I’ve been doing this long enough to know that there’s always another trade. Therefore, I will not be committing new money to the long side of the equity market at these levels in 2014.
The way I see it, there are two opposing forces at work here. First, we have the Federal Reserve Board that keeps pumping money into our economy. The Fed continues its easy money policies indefinitely. There are seven voting members of the Federal Reserve Board of Governors. Six of them have been broadly categorized as dovish, in favor of easy money/stimulus. There are four more rotating members from the national Federal Reserve Banks. This is where things may get a bit interesting. Three of the rotating members gaining a vote in 2014 are centrist to hawkish. While the doves are still clearly in control, especially with Janet Yellen expected to assume the Presidency of the Board, the dialogue in the minutes of their meetings could change substantially.
The easy money policies have favored the equity markets in a couple of different ways. The artificially depressed interest rates have forced investors to accept more risk for returns that used to be outside the scope of retiree investing. The stretch for yield has driven a boom in riskier corporate bonds as investors move down the ladder in an attempt to maintain their portfolio’s value. This has caused a surge in lower credit bond prices reminiscent of the sub prime mortgage debacle of the mid 2000’s. Investors’ lack of satisfaction with the governmentally manipulated yield curve has led them to seek returns in the stock market specifically, through high yield investments like Real Estate Investment Trusts and utilities. What has gone unnoticed is the disappearance of nearly half of the companies listed on U.S. exchanges. Therefore, there’s more money than ever chasing a smaller number of stocks in the last 25 years.
Secondly, we have reached valuations that bode poorly for long term investing. Research abounds on the usefulness of long-term valuation models. Very simply, expecting these returns to continue through long-term investment at these valuations would set an historical precedence. Anything can happen in the world of markets but the odds clearly show that bull markets do not begin when the P/E ratio of the S&P 500 is above 15. The S&P 500’s P/E ratio currently stands above 19 and Nobel Prize winning Yale economist Robert Schiller’s cyclically adjusted price earnings (CAPE) ratio is over 25. Both of these will continue higher as long as the equity markets continue to climb. Neither is sounding the, “Everyone to cash,” alarm bell. Their history simply suggests that it would be foolish to expect these multiples to continue to climb and climbing P/E ratios are necessary for stock market growth.
Closing in on 2014 has left many money managers whose performance is benchmarked against index averages scrambling to catch up. There are two ways a manager can do this. First, wait for a sell off and try to buy in at a discount. This is part of the reason that the weakness in July, August and October was so quickly recovered. Second, apply leverage so that the manager’s fund gains more than $1 for every $1 the market moves. Leverage seems to be the move of choice. This year has seen a huge inflow into equity mutual funds, which have to be benchmarked to their index. By comparison, each of the last two years saw net equity mutual fund outflows. The added influx of cash has led investment managers into the futures markets, specifically the S&P 500 futures. The most recent Commodity Futures Trading Commission’s Commitment of Traders report shows a 10% growth in leveraged longs as well as a 5% decline in leveraged shorts. Finally, margin debt on the stock exchange itself has also reached an all time high.
The case I’ve laid out says nothing about where we’re going. Liken this presentation to a new home survey. The place has curb appeal. The neighborhood is growing. The government is supporting its growth. Each new home sells for more than the last. What could be wrong with buying now? Well, the inspector may inform you that everything you believe to be true is resting on a shaky foundation. The house may stand for years or, not. Personally, I’d rather be in on the ground floor than looking for a window to jump out of having climbed in at the top.
Gold and silver have exploded in recent years. The contributing factors of low interest rates, economic uncertainty, global fear and pending inflation have done their share to boost precious metals’ outsized gains relative to the stock market. Gold has rallied more than 150% over the last five years while the broad stock indexes are all flat to lower, depending on the day. Silver, for its part, has nearly doubled in the last five years. Given our still historic low interest rates and the growing economic trouble overseas as well as our ballooning governmental budget deficit, it’s reasonable to believe that the forces behind this trend continue to remain intact. The question has changed from, “Should I be invested in precious metals,” to “What’s the most cost effective way to maintain a presence in precious metals.”
The boom in the precious metals market has brought with it the familiar hype of the gold bugs. It has also fostered the invention of precious metal Exchange Traded Funds (ETF’s) and cash for gold TV commercials. Commodity futures markets have also benefited from the added attention being paid to gold. Each of these has a place in the marketplace and each has a vested interest in hyping their product as the one that’s best suited to your needs. However, if you are ascribing to efficient portfolio theory and seek to include precious metals ownership as a part of your portfolio diversification plan, the best bang for your buck is through commodity exchange traded contracts which are regulated by the Commodity Futures Trading Commission (CFTC) and guaranteed by their appropriate exchange.
The market sectors mentioned above can be lumped into two categories: small speculators and investors. Gold bugs and cash for gold are for people with left over jewelry, some family heirlooms and gold coins like American Eagles or South African Krugerrands. Typically, this type of gold ownership sell side biased. This means owners of small pieces or collections are keeping an eye on price and hoping to sell when they think the market has peaked. When they bring their physical collections to market, they will end up at the coin shops, pawn shops, cash for gold, or their local jewelry shop. The willing buyers are always waiting and ready to pay below market value for collections that may have taken a lifetime to accumulate. Upon recent survey of the available outlets, prices to be paid were typically $40 per oz under market value for gold and $.30 per oz under market value for silver. Those on the buy side of this equation, looking to add to their private physical collections will find themselves paying up $30 – $50 per oz over market value in gold and up to $1.20 over per oz in silver. Therefore, small speculators in the physical precious metals market may lose more than 10% of the value of their collection in the buying and selling process.
Passive investment in the precious metals can be done in two ways, ETF’s and commodity exchange traded products. The benefits of ETF’s are that the amount to be invested can be determined beforehand and the investor can pick their own allocation, even if that amount is less than the price of one ounce of gold. The downside is these ETF’s typically underperform the actual market they are designed to track. Typically, one would expect a dollar for dollar rise and fall between the price of the metal and the value of the account. However, due to administrative fees, expenses, incentive fees, cost of acquisition, advertising, etc, the longer the ETF trades, the further behind the actual price they fall. Therefore, it is possible to lose money in a flat market, or realize a smaller return than one would expect in a rising market.
Finally, exchange traded commodity contracts like those listed with the Chicago Mercantile Exchange Group are the actual proxy to which ETF’s and local dealers tie their prices. Perhaps the single biggest drawback to these products is their preset size. There are about half a dozen precious metals products listed ranging in full cash value from $18,000 to $125,000. These contracts have several benefits for passive portfolio diversification. First, these are standardized products fully assayed and certified by the appropriate exchange. This assures the investor that their 100 ounces of gold is 24 carat and their silver is .9999 fine and that the value of your holdings can be found 24 hours a day, rather than being quoted by the guy in the shop down the street. Secondly, there are no administration fees, advertising costs, or incentive fees. The only charge is a one- time commission to your commodity broker, typically, around $50 per contract. Also, you will control the actual metal and not find yourself invested in mining sales or land right options because you didn’t read the prospectus thoroughly. Finally, the biggest reason exchange traded products are so much more cost effective is the use of margin and the amount of cash it frees up for the individual investor. The $18,000 contract mentioned above requires a cash deposit with the exchange of $1,150. This allows the individual investor to use the remaining $16,850 in excess cash for a money market account and earn interest on top of any return produced in the actual market itself. Therefore, those wishing to pursue efficient portfolio theory and diversify their holdings can most efficiently implement this process through the use of commodity futures markets.
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 in investing in futures.
This blog is published by Andy Waldock. Andy Waldock is a commodity futures 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 in investing in futures.
This morning’s (10/29/09) GDP headline on MSNBC reads, “GDP Grows at Best Pace in Two Years.” Bloomberg says, “Economy Expands for First Time in a Year.” Lastly, CNN said, “Economy Finally back in gear.
Statistically, speaking, this morning’s GDP numbers showed growth of 3.5% for the third quarter. This breaks a four quarter string of steadily shrinking numbers. By definition, this uptick brings us out of, “recession.” This morning’s report looks great in the headlines, sounds good on the evening news and provides warm fuzzy water cooler conversation. However, I believe this is exactly the setup for the Double Dip Recession we’ve been talking about for quite some time.
Let me paraphrase the economic definition of “recession. “ A recession occurs when an economy has two consecutive quarters of declining GDP. We had experienced four straight quarters of declining GDP prior to this morning’s report. In a free market economy, I would join the water cooler conversation and breathe a collective sigh of relief. However, our economy over the last year, can hardly be called a, “free market economy,” and therefore, I will continue to hold my breath and face the realities of what I believe will be a SIGNIFICANT downturn in our country’s economic stability.
Over the last quarter, the economic effect of the government’s cash for clunkers and housing stimulus packages has been substantial. Unfortunately, the temporary stimulus has done nothing to fix the underpinnings of our country’s global ability to compete into the future. These programs were far more akin to giving a man a fish, rather than teaching a man to fish. Had we allowed the markets to work themselves out, we would have saved billions of taxpayer money that went to bail out worthless financial corporations. Had some of this money been spent on our country’s infrastructure instead, we would have created new jobs by updating the electrical grid and allowing new green energy to be transferred from where it’s created to where it’s needed. The highway system, bridges and railways haven’t been significantly updated since their creation in the 1950’s and are in dire need of repair. As I write this, I see that the Golden Gate Bridge is closed because a cable snapped! Finally, high speed internet needs to be rolled out to everyone, just like the phone companies did so many years ago. These INVESTMENTS in our country’s future would do far more to ensure long term growth than the corporate BAILOUTS we are paying for to make us feel good now.
Due to the programs that have been implemented, we have ended the recession. Hurray for us – NOT. What we have done is placed whip cream and cherries on a pile of cow dung. Let me blow the froth off and show you how much it smells underneath the rhetoric. Deflation is still our major economic concern. Deflationary economies have no chance of sustaining growth. Many of you will argue that because of the falling Dollar and our government’s position of Quantitative Easing, that inflation should be our primary concern. I don’t think that’s the case.
First of all, we still have rising unemployment. According to the last unemployment report, we are at 9.8% unemployed. There are also another 7% underemployed and another 3-4% who’ve simply quit looking for work. According to John Mauldin, “A few years ago, 1 in 16 Americans were unemployed or underemployed. Today, that number is 1 in 5.” Obviously, this means no wage inflation. This is also why I think national infrastructure retooling would’ve been more beneficial. Secondly, between the housing collapse and the bear market in equities, we have seen significant wealth destruction. People are increasing their rate of savings as their net worth declines. Haven’t we all tightened our collective belts a bit? Again, lack of spending equals deflation not, inflation. Finally, the Federal Reserve Board has dropped interest rates to near 0%. Typically, this would be extremely stimulative and very inflationary. However, the money the Fed is printing is not making it to out to home buyers, entrepreneurs or, small businesses. The money is being used to shore up the balance sheets of the many troubled lending institutions at the corporate and private levels. Therefore, the velocity of money is still very low in spite of the amount of money the Fed has been printing and money velocity is positively correlated with inflation. Low velocity means low inflation.
This morning’s GDP numbers need to be taken in context. The dip was halted but, it’s just a breather before the next section of the slide. Watch the Commitment of Traders Reports for the next selling opportunity.
This blog is published by =
Waldock. Andy Waldock is a commodity futures trader, analyst, broker and asset manager.
Therefore, Andy Waldock may have positions for himself, his family, or, =
clients in any market discussed. The blog is meant for educational =
to develop a dialogue among those with an interest in the commodity =
The commodity markets employ a high degree of leverage and may not be =
for all investors. There is substantial risk in investing in =
I was going to write an article this morning on =
broken markets. My definition of a, “broken market,” is one in =
the fundamentals, like the Commitment of Traders Reports and technicals are at odds with each other. Clearly, we =
witnessing this in the equities markets. However, when I read the =
article in the Washington Post, I realized just how disjointed the =
markets are from reality. How can top end wages increase at 4+% =
is nil and unemployment is pushing 10%?
By Tomoeh Murakami Tse
updated 4:35 a.m. ET, Tues., Oct . 20, =
NEW YORK – Even as the nation’s biggest financial =
struggling and the federal government was spending hundreds of billions =
dollars to save many of them, the companies as a group were boosting the =
and benefits they pay their chief executives.
The firms, accounting for more $350 billion in =
bailout funds, increased these perks and benefits 4 percent on average =
year, according to an analysis of corporate disclosures filed in recent =
Some chief executives, such as Kenneth D. Lewis of =
America and Jeffrey M. Peek of CIT Group, the major small-business =
on the brink of bankruptcy, each received about $100,000 more than a =
earlier for personal use of corporate jets. Others saw an increase in =
of chauffeured services, parking or personal security.
Story continues below ?advertisement | your ad =
Ralph W. Babb Jr., chief executive of Dallas-based =
Comerica, was compensated for a new country club membership, with an =
fee and dues of more than $200,000. GMAC Financial Services chief =
Alvaro de Molina benefited from a $2.5 million payment from his company =
cover his personal tax bill.
“You would have thought that this would be the =
when everyone said, ‘Okay, the perks have got to stop — at least =
we’re indebted to the government,’ ” said Paul Hodgson, senior =
associate at the Corporate Library. “But that didn’t =
This year may turn out to be different. In June, =
Treasury Department prohibited companies receiving bailout funds from
reimbursing senior executives for their personal tax =
In the meantime, Kenneth R. Feinberg, the Obama
administration official assigned to set pay for top executives at seven =
companies receiving the most help, plans to curtail perks such as =
fees when he rules on compensation later this month, according to people
familiar with the matter. Perks worth more than $25,000 are getting =
scrutiny from Feinberg.
On average, the chief executives at 29 of the =
financial companies that have taken bailout funds received perks and =
worth more than $380,000 in 2008, according to compensation figures =
annual proxy statements and supplied by Equilar, a compensation data =
firm. Individually, about half the banks increased their fringe benefits =
top executives. The figures do not include relocation costs and related =
typically one-time fees that can skew year-over-year =
In contrast to the 4 percent average increase in =
benefits at these companies, the average awarded to top executives at
non-financial companies in the Fortune 100 declined by more than 7 =
the same period, according to Equilar.
of this e-mail communication and any attachments are for informational =
only and under no circumstances should they be construed as an offer to =
a solicitation to buy any futures contract, option, security, or =
including foreign exchange. The information is intended solely for the =
and confidential use of the recipient of this e-mail communication. If =
not the intended recipient, you are hereby notified that any use,
dissemination, distribution or copying of this communication is strictly
prohibited and you are requested to return this message to the sender
immediately and delete all copies from your =
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 in investing in futures.
I received the following email from one of my more erudite customers. I think, between us, we raised more questions than we answered. You will see my response below. Andy, I sent that same article (Swiss Bank say “goodbye to US”) to a European friend that I frequently have global economic discussions with. He excused it as the “Swiss being the Swiss”. He said they have been complaining for years as almost all of the European countries have demanded the same transparency from them. He feels that their historic dependence on secrecy and neutrality has been crumbling as the world gets smaller and hasn’t seen them as “playing ball”. This is the sound of a “baby crying because its not getting its way”. They used to command respect in international finance, but are becoming far less significant or impactful. Excuse it. Ignore it, he said. It signals desperation, as to lash out against the US is an old European ploy to garner support from there brothers on “the continent”, in a “we stand together” approach. He reminded me that their list of complaints about the US government approach to the economy and the private sector is, 1) well know , and, 2) the same complaints that you hear in the US itself. “Who needs them to remind us of the obvious? Its just rubbish! Throw it away.” Interesting …………… As I constantly try to summarize and update my outlook, her are my latest random thoughts……. Although a double dip recession is theoretically possible, what are the realistic chances when money is being printed around the world and interest rates are so low?? As our major companies have globalized over previous decades, and that pace continues to accelerate, is the statistical relevance of the US economic indicators disconnecting from our own stock market? So many of our prognosticators and experts base there predictions and interpretations on models built from another era. The rest of the world’s indicators are showing a bottom in place and a standard upturn based upon overprinting of currency and low interest rates – full steam ahead. The fact is that we have the same, but our banks are holding onto money to protect themselves from the government changing the rules, and the housing glut is feeding the negative impact on household wealth perceptions. So, our government policy nightmare could feed domestic fears of deflation, economic slowdown, and continued unemployment, while the rest of the world is full steam ahead. They may worry about potential inflation, fed by the voices of the gold bugs and their own fears based upon many a small country’s own history. But as you rightly pointed out, it will not be based upon scarcity of labor, material, or capital. But those three factors usually only come into play at the end of the cycle. Inflation is prompted by too much cheap money funding speculation, which fuels growth, expansion, hyper growth and eventually scarcity of labor or material (usually not capital, as what politician in his/her right mind would shut off the spigot which provides their power?) And since in a globally developing world with 2/3 of the population at poverty levels, and global companies able to readily locate or relocate production to cheaper labor markets – labor inflation will not be a problem. This leaves only material, raw or manufactured, as the instrument of limited supply – too much money chasing limited supply. And those with true needs for production, will be punished by speculators crowding into their space. Gold is a monetary option, not an inflation indicator. It is a currency equalizer. It has risen in response to the drop in the USD, which is in response to our government’s unclear policies. Gold should drop when these become clearer (the rules of the game) and the game restarts. Although the floor has risen as all currencies are being devalued. Also, has the education of the US investors expanded sufficiently that global investing differentiation has reached the level whereby their personal wealth could be positively impacted by successful investment returns from emerging or global markets, such that they spark retail here? Or will they focus on reinvesting to rebuild wealth (having been burned recently) and link consumption directly to job security and taxes? We are seeing the condensed cycles we discussed previously. Easy money has only been around for a year and already everyone’s worried about inflation. So where does that leave me? With the intention of getting in early and out on time ….. Short term (start of cycle) opportunities would appear to be: Emerging market stocks, and US stocks of global companies, or banks, small companies with a global labor supply or consumer market but little exposure to materials with potential price spikes or limited supply (SHIT !!!!!! Just realized I’m in the wrong business !!!!) Perhaps some real estate. Middle term (mid cycle) opportunities would appear to be: Global stocks and US stocks of global companies, raw materials with limited supply or long windows of new supply coming on stream Long term (late cycle) opportunities would appear to be: Start looking for tops: to short all stocks, to sell commodity futures, End of cycle opportunities: Short everything, buy bonds (as interest rates will need to be lowered in the next recession), hold cash (to start buying at the beginning of the next cycle). What should I do today? Looks like commodities should have a floor, due to cheap money and economic recovery world wide. So I should stop shorting against minor pullbacks. Perhaps the only fear of a double dip is domestically? Although global growth is recovering, it is no where near levels to spark commodity demand – just speculation due to cheap money, and limited alternatives. Commodities may stay in a range for some time. (When gold retreats, so will many other commodities) Play USD recovery when policies become clearer. Invest in merging markets. Drink wine…. My response: There’s an awful lot to go on here. PhD’s are working overtime to generate responses to each of your individual questions and you expect me to digest it, whole? I do have a couple of thoughts on some of your points. I’ve read it three times now, and I think I’m starting to wrap my head around it. 1) Double dip recession – I think it’s very likely if the tax plans go through. It seems to me that taxes will rise and this will hurt our economy both by slowing new employment and, in turn, undercutting federal estimates of planned tax collection. Furthermore, these taxes will provide no long term benefits whatsoever to our infrastructure, our individuals or, our corporations. As you and I have discussed, profits have come through cost cutting and one time stimulus injections. We’re generating zero domestic demand and our exports are increasing, primarily, through the effect of the declining Dollar and its effect on the agricultural markets. Finally, on the inflation/deflation debate of the double dip, I think I’ve gotten my head around to the following argument for deflation as our primary focus. We’ve already had the excess land and labor argument and I think deleveraging has put a damper on capital demand. Throughout the financial crisis, we have g
lobal deleveraging on an unprecedented scale. In addition, the money that the governments are printing is going into a banking system where it is being used by the to fix their own balance sheets. Therefore, the newly printed money is not being lent out, has no velocity and is generating less inflation than would historically be the case. 2) I tend to think that models have a finite lifespan. Through my experiences in programming them, I have separated quite a bit of wheat from the chaff. There are technical indicators showing our bottom in place like the major divergences in negative momentum from the March lows. There are fundamental indicators like the explosion in jobless claims two months ago or, so followed by declining claims that tends to serve as a predictive indicator. There are the earnings reports, particularly in the financials, that all would indicate the worst is behind us. Remember when the LIBOR (see U.S. Interest Rate Futures) had its own 24 hour window on CNBC through the crisis? I think that globalization has put the U.S. markets in a basket of “tradeable markets.” It’s no different than U.S. investors placing money overseas. Any investor is simply looking for return on investment. As long there are sectors or, markets as a whole, people will design new trading strategies to increase their risk to reward ratios and, in doing so, become less concerned with a market’s internals as the day’s closing price will be the only meaningful metric. This WILL continue to create bubble after global bubble. We will ALWAYS seek out our own financial best interest. The education of U.S. investors is to ride the wave until it crashes then, look for the next one. Ignorance is bliss the whole way into the beach. 3) Where do we stand in the cycle? The simple version is to invest anywhere there is a growing middle class with an historically high savings rate, both in population and demographic. That description does not exist domestically.
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 in investing in futures.
It has been noted that the U.S. Dollar makes a high or a low for the year in January approximately 2/3 of the time. Some prominent market mavens are attributing the Dollar’s strength to “strong cyclical forces at play” while others believe that the Dollar’s time as the currency of last resort is nigh. Both positions appear, to me, to be based on more on rhetoric and black magic than on sound fundamental analysis. Those of you who’ve asked me about the Dollar have gotten the same response from me since the commodity futures market’s bottom in December. I don’t understand the Dollar’s strength. I can advise on technical levels and pattern recognition but, I don’t have a fundamental thesis to frame my trading in this market at this time. The following article by John Mauldin of www.frontlinethoughts.com has provided me with a framework I can wrap my head around. I hope it helps you as much as it has myself.Andy.
The Risk in Europe
I mentioned last
week that European banks are at significant risk. I want to follow up on that
point, as it is very important. Eastern Europe has borrowed an estimated $1.7
trillion, primarily from Western European banks. And much of Eastern Europe is
already in a deep recession bordering on depression. A great deal of that $1.7
trillion is at risk, especially the portion that is in Swiss francs. It is a
story that could easily be as big as the US subprime problem.
In Poland, as an
example, 60% of mortgages are in Swiss francs. When times are good and
currencies are stable, it is nice to have a low-interest Swiss mortgage. And as
a requirement for joining the euro currency union, Poland has been required to
keep its currency stable against the euro. This gave borrowers comfort that they
could borrow at low interest in francs or euros, rather than at much higher
But in an echo of
teaser-rate subprimes here in the US, there is a problem. Along came the
synchronized global recession and large Polish current-account trade deficits,
which were three times those of the US in terms of GDP, just to give us some
perspective. Of course, if you are not a reserve currency this is going to
bring some pressure to bear. And it did. The Polish zloty has basically dropped
in half compared to the Swiss franc. That means if you are a mortgage holder,
your house payment just doubled. That same story is repeated all over the
Baltics and Eastern Europe.
have lent $289 billion (230 billion euros) to Eastern Europe. That is 70% of Austrian
GDP. Much of it is in Swiss francs they borrowed from Swiss banks. Even a 10%
impairment (highly optimistic) would bankrupt the Austrian financial system,
says the Austrian finance minister, Joseph Proll. In the US we speak of banks
that are too big to be allowed to fail. But the reality is that we could
nationalize them if we needed to do so. (And for the record, I favor
nationalization and swift privatization. We cannot afford a repeat of Japan’s
The problem is
that in Europe there are many banks that are simply too big to save. The size
of the banks in terms of the GDP of the country in which they are domiciled is
all out of proportion. For my American readers, it would be as if the bank
bailout package were in excess of $14 trillion (give or take a few trillion).
In essence, there are small countries which have very large banks (relatively
speaking) that have gone outside their own borders to make loans and have done
so at levels of leverage which are far in excess of the most leveraged US
banks. The ability of the “host” countries to nationalize their banks
is simply not there. They are going to have to have help from larger countries.
But as we will see below, that help is problematical.
banks have been very aggressive in lending to emerging market countries
worldwide. Almost 75% of an estimated $4.9 trillion of loans outstanding are to
countries that are in deep recessions. Plus, according to the IMF, they are 50%
more leveraged than US banks.
Today the euro
rallied back to $1.26 based upon statements from German authorities that were
interpreted as a potential willingness to help out non-German (in particular,
more sobering note from Strategic Energy was sent to me by a reader. It nicely
sums up my concerns:
“It is East
Europe that is blowing up right now. Erik Berglof, EBRD’s chief economist, told
me the region may need €400bn in help to cover loans and prop up the credit
system. Europe’s governments are making matters worse. Some are pressuring
their banks to pull back, undercutting subsidiaries in East Europe. Athens has
ordered Greek banks to pull out of the Balkans.
needed are beyond the limits of the IMF, which has already bailed out Hungary,
Ukraine, Latvia, Belarus, Iceland, and Pakistan — and Turkey next — and is
fast exhausting its own $200bn (€155bn) reserve. We are nearing the point where
the IMF may have to print money for the world, using arcane powers to issue
Special Drawing Rights. Its $16bn rescue of Ukraine has unravelled. The country
— facing a 12% contraction in GDP after the collapse of steel prices — is
hurtling towards default, leaving Unicredit, Raffeisen and ING in the lurch.
Pakistan wants another $7.6bn. Latvia’s central bank governor has declared his
economy “clinically dead” after it shrank 10.5% in the fourth
quarter. Protesters have smashed the treasury and stormed parliament.
much worse than the East Asia crisis in the 1990s,’ said Lars Christensen, at
Danske Bank. ‘There are accidents waiting to happen across the region, but the
EU institutions don’t have any framework for dealing with this. The day they
decide not to save one of these one countries will be the trigger for a massive
crisis with contagion spreading into the EU.’ Europe is already in deeper
trouble than the ECB or EU leaders ever expected. Germany contracted at an
annual rate of 8.4% in the fourth quarter. If Deutsche Bank is correct, the
economy will have shrunk by nearly 9% before the end of this year. This is the sort
of level that stokes popular revolt.
implications are obvious. Berlin is not going to rescue Ireland, Spain, Greece
and Portugal as the collapse of their credit bubbles leads to rising defaults,
or rescue Italy by accepting plans for EU “union bonds” should the
debt markets take fright at the rocketing trajectory of Italy’s public debt
(hitting 112pc of GDP next year, just revised up from 101pc — big change), or
rescue Austria from its Habsburg adventurism. So we watch and wait as the lethal
brush fires move closer. If one spark jumps across the eurozone line, we will
have global systemic crisis within days. Are the firemen ready?”
While Rome Burns
I hope the writer
is wrong. But the ECB is dithering while Rome burns. (Or at least their banking
system is — Italy’s banks have large exposure to Eastern Europe through
Austrian subsidiaries.) They need to bring rates down and figure out how to
move into quantitative easing. Europe is at far greater risk than the US.
Great Britain and
Europe as a whole are down about 6% in GDP on an annualized basis. The Bank
Credit Analyst sent the next graph out to their public list, and I reproduce it
In another longer report, they note that the UK, Ireland, Denmark, and
Switzerland have the greatest risk of widespread bank nationalization (outside
of Iceland). The full report is quite sobering. The countries on the bottom of
the list are also in danger of having their credit ratings downgraded.
This has the
potential to be a real crisis, far worse than in the US. Without concerted
action on the part of the ECB and the European countries that are relatively
strong, much of Europe could fall further into what would feel like a
depression. There is a problem, though. Imagine being a politician in Germany,
for instance. Your GDP is down by 8% last quarter. Unemployment is rising.
Budgets are under pressure, as tax collections are down. And you are going to
be asked to vote in favor of bailing out (pick a small country)? What will the
voters who put you into office think?
We are going to
find out this year whether the European Union is like the Three Musketeers. Are
they “all for one and one for all?” or is it every country for
itself? My bet (or hope) is that it is the former. Dissolution at this point
would be devastating for all concerned, and for the world economy at large.
Many of us in the US don’t think much about Europe or the rest of the world,
but without a healthy Europe, much of our world trade would vanish.
all the parties to agree on what to do will take some serious leadership, which
does not seem to be in evidence at this point. The US almost waited too long to
respond to our crisis, but we had the “luxury” of only needing to get
a few people to agree as to the nature of the problems (whether they were wrong
or right is beside the point). And we have a central bank that could act
As I understand
the European agreement, that situation does not exist in Europe. For the ECB to
print money as the US and the UK (and much of the non-EU developed world) will
do, takes agreement from all the member countries, and right now it appears the
German and Dutch governments are resisting such an idea.
As I write this
(on a plane on my way to Orlando) German finance minister Peer Steinbruck has
said it would be intolerable to let fellow EMU members fall victim to the
global financial crisis. “We have a number of countries in the eurozone
that are clearly getting into trouble on their payments,” he said.
“Ireland is in a very difficult situation.
euro-region treaties don’t foresee any help for insolvent states, but in
reality the others would have to rescue those running into difficulty.”
That is a hopeful
sign. Ireland is indeed in dire straits, and is particularly vulnerable as it
is going to have to spend a serious percentage of its GDP on bailing out its
It is not clear
how it will all play out. But there is real risk of Europe dragging the world
into a longer, darker night. Their banks not only have exposure to our US
foibles, much of which has already been written off, but now many banks will
have to contend with massive losses from emerging-market loans, which could be
even larger than the losses stemming from US problems. Plus, they are more
leveraged. (This was definitely a topic of “Conversation” this
morning when I chatted with Nouriel Roubini. See more below.)
The Euro Back to Parity? Really?
I wrote over six
years ago, when the euro was below $1, that I thought the euro would rise to
over $1.50 (it went even higher) and then back to parity in the middle of the
next decade. I thought the decline would be due to large European government
deficits brought about by pension and health care promises to retirees, and those
problems do still loom.
It may be that
the current problems will push the euro to parity much sooner, possibly this
year. While that will be nice if you want to vacation in Europe, it will have
serious side effects on international trade. It clearly makes European
exporters more competitive with the rest of the world, and especially the US.
It also means that goods coming from Asia will cost more in Europe, unless
Asian countries decide to devalue their currencies to maintain an ability to
sell into Europe, which of course will bring howls from the US about currency
manipulation. It is going to put pressure on governments to enact some form of
trade protectionism, which would be devastating to the world economy.
Large and swift currency
swings are inherently disruptive. We are seeing volatility in the currency
markets unlike anything I have witnessed. I hope we do not see a precipitous
fall in value of the euro. It will be good for no one. It is a strange world
indeed when the US is having such a deep series of problems, the Fed and
Treasury are talking about printing a few trillion here and a few trillion
there, and at the very same time we see the dollar AND gold rising in value.
What a Cycle! – Part 2
The first part of this cycle generated large amount of feedback. Many customers were calling with the same questions. “How do I do it?” How do I use commodity futures hedge my portfolio if I think there is further downside?” I also received the opposite question, “I don’t think this will last forever. How do I take advantage of the move back up?”
First, let’s deal with some basic mathematical issues and market barometers. The Dow peaked at 14,198 on October 11th. Currently, we are around 10,600. This is a decline of almost 3,600 points or, 25%. Now, if we were to bottom here, and I’m not saying we will, the 25% decline lost in the blue chips will need a rally of 34% to reach the same highs.
Here is a table for the other indices:
Market High Current % Decline % Rally to Reach Highs
S&P 500 1576 1140 25 38
Russell 2k 857 658 23 30
Nasdaq 100 2239 1137 49 97
NYSE Comp 10301 7319 29 41
The Point here is to illustrate that an account that is off 25% is going to need far more than a 25% rally to get back to even. Now, the month of September was particularly brutal. The S&P lost more than 13%. I went back to 1970 and I could only find nine other occurrences when the S&P lost more than 9% in one month. Unfortunately, the months following the decline don’t show a clear pattern. However, a couple of general assumptions can be made. First, the worst of the decline is usually over. The market is steady to higher in eight out of nine observations. Also, the market can rally substantially from oversold levels as we saw in 1998 and 2002.
close + 1
two months later c + 3
Now, for the practical concerns of implementing an equity portfolio enhancing futures strategy we can begin with some practical portfolio composition issues. Let’s assume that one has a $100,000 portfolio and at this point is allocated to 50% stocks, 30% bonds and 20% cash. Using the S&P as a broad market proxy, the equity portion has lost 25% of its value and now has a current market value of $37,500. Sobering, isn’t it? As we discussed earlier, the S&P will have to rally 38% for the equity portion of this portfolio just get back to where it was one year ago. Does anyone want to add in the attrition of a 5% inflation rate?
Here are the tools we have to work with.
Market Contract Size Margin
S&P500 $285,000 $22,500
Mini S&P $57,000 $4,500
Russell 2K $329,000 $26,250
Mini Russ $65,800 $5,250
Dow $106,000 $7,005
Mini Dow $53,000 $3,503
Also, we have an entirely different commodity futures product called Single Stock Futures. These have been around for a couple of years and have built up pretty good volume. There are a few important things to know. First of all, SHORT TRADES are allowed. Secondly, they are 100 share contracts at 10% margin. In other words, Microsoft trading at $26 dollars a share in single stock futures would be worth the trade price multiplied times 100 shares or, $2,600. The margin, at ten percent of contract value, is only $260.
Therefore, these products can be used by smaller accounts or, to protect individual market sectors and individual issues. For example, there is a single stock banking industry contract, as well as several others. The Narrow Based Indexes can be traded just like the futures indexes because they are cash settled, which eliminates any delivery issues.
Here are the single stock futures with the highest open interest as of 9/30.
Verizon Kraft Chevron Corp. Bristol-Myers Squibb Wyeth
Juniper Networks Inc. Exelon Corp. Boeing Co. Marsh & McLennan Co.
I think this provides a good detail of the products that are available and the actual dollars involved in trading. The last step is making the transition from cautiously reading and internalizing the information to actually putting this information to use in your own accounts. I understand that no one wants to accept the current values of their portfolios. Believe me, I get it. However, for those who did nothing on the way down, hoping that it would, or will, turnaround, I strongly suggest putting these products to work in your own accounts. I will be happy to discuss an appropriate combination that makes sense for your portfolio and your objectives.
Lost in the Confusion
Amid the roar of the financial chaos and their ability to affect,
seemingly every market, one sector has been quietly building a base and should
be renewing buying interest. Remember back in late May and June during the
wettest spring ever when the concerns of crop planting were making the local
news? The ensuing run up in grain prices soon had everyone beating the drum of ethanol’s
demand on corn prices and the cost of bread, chips and cereal.
Since the grain markets peaked in July, many of them have
sold off considerably. Soybeans have fallen from an all time high of $16.47
down to $11.00 per bushel. Corn and wheat are also off 30 – 35%. The main
reasons for this sell off has been the exceptional growing conditions helping to
make up for the wet spring as well as the typical seasonal pattern the grain
markets have of selling off once the crop has been planted. Further pressure
was added this summer by the rise in the U.S Dollar and the global demand
reduction associated with increasing purchase costs as a result of the exchange
Soybeans and wheat continued to decline this past week amid
the global uncertainty of the financial markets and a general flight from
derivative based investment. However, corn made its low of $5.00 per bushel
more than a month ago. Also, the corn market failed to make new lows amid the
financial panic. Technically, corn need only close above $5.67 to setup a
genuinely bullish breakout of a double bottom.
Fundamentally, while the corn crop has grown well, the late
planting has had an effect on the maturation process of the crop. The saying
being floated by the corn pundits is, “Looks good from the road but not in the
field.” This year’s crop will be especially vulnerable to an early frost or
cool late summer as the late planting is affecting the finishing of the crop.
Lastly, and most importantly, the global corn crop began this year at one of
the tightest stocks to usage ratio on record. Basically, this means that there
was less of the previous year’s corn crop still available in the pipeline at
the beginning of this year’s planting season.
It appears in the USDA grain reports that given the acreage planted, the projected
yield and demand for this year’s crop will do little to ease this issue. While
we move to global “on demand inventory,” it’s important to know that commodity futures
supplies are static. Government’s can print money. Stock exchanges can forbid
short selling and banks can be bailed out. However, neither the U.S. Federal
Reserve nor the European or English Central Banks can create more corn. Those
who have been losing sleep over the next financial market, “Breaking News
Bulletin,” may wish to consider something more grounded.
Hurricane season has brought about some unintended
consequences which are my job to find as a commodity broker. The one least likely to make the news is their effect on hog and
cattle prices. Every time people are forced to flee and cities lose their
power, we see a rally in meat prices. Loss of power creates a temporary demand
shock to the system. Every individual and grocer has to trash every piece of
meat in their home or store.
This didn’t actually hit until the blackout in August of ’03.
I was prepared for the stock market’s initial sell off followed by a huge rebound
based on the public selling the market off on the terrorism fears and buying it
back with a vengeance when it was ruled out. That trade lasted from Sunday
night until Tuesday morning, just as I planned. However, over the next week and
a half, I watched the hog and cattle markets climb and climb. At that time, I
didn’t have the forethought to forecast the demand shock of the replacement
value of all of the perishable goods.
Hurricane Date Change Hogs Change Cattle
Floyd 9/16/99 11% 11%
Blackout 8/14/05 17% 28%
Isabel 9/18/03 19% 9%
Ivan 9/16/04 7.8% 2%
& 8/05 4.5% 9%
Rita 9/24/05 5% 3.5%
This morning’s trade will most likely, send all asset
classes lower. Obviously, this will include the commodity futures markets. Take
advantage of this morning’s weakness to establish long positions in perishable markets