June 2011

June 9, 2011 - It's Off to the Races for Natural Gas

Featured Trades: (ITS OFF TO THE RACERS FOR NATURAL GAS)

1) It's Off to the Races for Natural Gas. Name one of the best performing assets since the 'RISK OFF' trade started and it would have to be natural gas. You may recall my waxing bullish on this simple molecule in my piece seven weeks ago (click here for 'Something is Bubbling in Natural Gas'). Since then, natural gas has rocketed by 30%.

My call then was to wait for the cold summer that the weather models were then predicting to crater this clean burning fuel and load up on the cheap. It seems that the weather models are never right. Instead, The US East Coast is suffering a broiling summer, and it has been off to the races for natural gas.

There have been other structural developments that have helped boost prices for CH4. With oil prices over $100 a barrel, the integrated majors are diverting rigs to new onshore oil development where the huge profits are, instead of using them to extract more underpriced gas. So gas rig counts are down, and industry insiders don't expect an upturn until gas gets up to $7-$8/BTU, up from the current $4.85. This is limiting new supplies coming on stream from shale gas unlocked by the new 'fracking' technologies.

On top of that, an increasing number of utilities are taking advantage of low gas prices to switch over from coal. Others are making the change purely for environmental reasons, as natural gas produces only half the CO2 emissions and none of the NO2 or SO3 when compared to oil fired plants. The last coal fired plant in California was recently closed, where utilities like PG&E (PGE) are racing to obtain 30% of their power from alternatives by 2020. This is why the International Energy Agency expects American natural gas demand to increase by 50% over the next five years.

What's more, traders no longer have to fear weather spikes from gas prices, like the hurricanes of the past, as so much of the new gas supplies are coming from onshore. Very little new gas now comes from the Gulf of Mexico when compared to past years.

Longer term, the 800 pound gorilla for this market is the prospect of exports to Asia, especially energy hungry China. They haven't started yet as the infrastructure is not in place, but it is under construction. When that happens you can expect the crude/natural gas price gap to disappear. Gas currently sells for 20% of the price of crude on a BTU basis.

How to play it? Don't touch the ETF (UNG) which has one of the worst tracking errors in the industry. Instead, invest in individual producers, equipment suppliers, and pipeline companies, like Chesapeake Energy (CHK), Devon Energy (DVN), Cheniere Energy (LNG), and Southwestern Energy (SWN).

-

June 9, 2011 - Why the Banks Are Trading Like Grim Death

Diary

Featured Trades: (WHY THE BANKS ARE TRADING LIKE GRIM DEATH), (BAC), (WFC), (XLF)

2) Why the Banks Are Trading Like Grim Death. You may recall that I went on national television on April 22, proclaiming that Bank of America stock was a screaming short, then trading at $12.50 (click here for the link to the Fox Business News piece ). My logic was that another leg down in the residential real estate market would eat up a further dollop of bank capital, triggering a secondary banking crisis. Making that call spitting distance from the bank's California headquarters generated much local controversy.

What a difference seven weeks makes. Today, (BAC) hit a new two year low, plunging 16% since my April call, and 40% since the beleaguered bank's February peak. The action today is being driven by capitulation selling by hedge funds who drank the Kool-Aid, believing that real estate had bottomed, paving the way for a sustainable American economic recovery.

I believed in that scenario for about a month myself. My buy of (BAC) call options in December and my sale in January was one of my most profitable trades of the year. Since then, fat has been poured on the fire, with continued revelations about foreclosuregate and never ending controversy on mortgage resets, which the bank is loath to facilitate. Falling US interest rates have shrunk the positive carry that banks were using to recapitalize themselves. Now we have a generalized global equity sell off, dragging the stock down more.

Take a look at the chart below to see how the banks have been the worst performing sector of the market this year. Its peaking in February, along with similar negative action in technology, prompted me to turn bearish on all stocks and risk assets in general. It also prompted me to make my watershed call the 'RISK OFF' trade was about to ensure in my April 22 letter.

I sense that once bond prices peak, yields bottom, and the stock indexes firm up, there will be another chance to make a killing in bank stocks from the long side. But I would not be rushing into this one. Better to take a long vacation first, such as in London, Venice, Milan, Zermatt, and Geneva, as I plan to do.

-

Once More Around the Block Please.

It's Not Time to Buy Bank Stocks Yet

June 7, 2011 - The June 22 Geneva Strategy Luncheon is Sold Out

Diary

Featured Trades: (GENEVA STRATEGY LUNCHEON SOLD OUT)

2) The June 22 Geneva Strategy Luncheon is Sold Out. Due to the rush of last minute orders to participate in my June 22 Geneva, Switzerland strategy luncheon, the event has become sold out. Plead as I may with the hotel for a larger conference room to accommodate the overflow, it has nothing more available. Apparently, the hedge fund business is booming in Geneva these days, with the presentations to investors are coming hot and heavy, and the medieval city's infrastructure is unable to cope with demand.

For those unable to live without the latest, in person update on the markets from The Mad Hedge Fund Trader, I still have seats available at my Milan, Italy luncheon on June 20. That's probably because Italians don't like to work very much in the summer, as there are so many delightful distractions. If you can wait, I will probably schedule a lunch at other Swiss venues in the future, such as in Zurich, Zermatt, or St. Moritz. Until then, you'll just have to subsist on the newsletter alone.

Those Italian Distractions

June 7, 2011 - My Take on the 2012 Election

Diary

Featured Trades: (MY TAKE ON THE 2012 ELECTION)

3) My Take on the 2012 Election. This is going to be an interesting election. A Pew Research/Washington Post poll asked Republican voters to choose a word that best described their party's current field of presidential candidates. Here is a ranking of the words they chose:

unimpressive
disappointing
weak
good
incompetent
pathetic
unqualified
not interesting
idiots

Some 40% chose negative terms, while only 20% picked positive ones, with 40% undecided.

On the other hand, President Obama is going to have to run with plunging employment, residential housing in free fall, consumer confidence falling off a cliff, food and energy prices skyrocketing, and a dysfunctional government that is slowly sliding into bankruptcy. Can he become the first US president in history to win reelection with an unemployment rate over 7.2%.

If he does, it will only be with the assistance of Sarah Palin. The chief accomplishment of the Tea Party so far has been to hand the Senate in the last election to the Democrats in the 2010 election. This did this by fielding candidates who were weak, inexperienced, and incompetent in states like Nevada and Delaware where the Republicans should have otherwise won.

That pattern repeated itself two weeks ago in an upstate New York congressional by election where the Tea Party candidate took 9% of the vote, ensuring a Democratic win. Is Sarah Palin Alaskanese for Ross Perot, the last independent candidate who delivered a three way voter split that swept Bill Clinton into the top job?

Keep in mind that the election is still 17 months off, and in the world of politics that might as well be 17 centuries. After all, who outside of Illinois had ever heard of Barrack Obama 17 months before the last election? Then it was Hillary's to lose, and that is exactly what she did.

Is Sarah Palin Throwing the Election to the Democrats Again?

June 6, 2011 - The Nonfarm Payroll Bombshell

Diary

Featured Trades: (THE NONFARM PAYROLL BOMBSHELL)

1) The Nonfarm Payroll Bombshell. Any doubts about what the '?new normal' is all about were dispelled yesterday with the bombshell March Nonfarm Payroll Report showing a gain of only 54,000, the smallest in seven months, and a huge shortfall from the 190,000 consensus.

The headline unemployment rate bumped back up from 9.0% to 9.1%, taking the total number of unemployed to 13.9 million. The real U-6 unemployment rate including the long term jobless leapt to 15.8% totaling 24.1 million, and is closer to 20% in states like California.

Private sector employment rose by 83,000, with the biggest gains in business serves (44,000) and health care (17,000). Falls were seen in leisure and hospitality (-6,000) and manufacturing (-5,000). March and April reports were revised down 39,000.

The big hit was in government employment, which plunged by 29,000, all but 1,000 occurring at the local level. This trend is likely to accelerate in the summer, when many teachers already given pink slips are not rehired, as they were in years past. This is a trend that is likely to continue for another decade.

Let me give you a simple English lesson here. Spending cuts means job losses. Reducing the deficit means job losses. Balancing the budget means job losses. Austerity means job losses. And lots of job losses means slower economic growth. This reports shows that for every two workers hired by the private sector, one is fired by the government, leaving us with net job growth that is meager at best. Since the jobs recover started 18 months ago, the private sector has added an impressive 2.2 million, while the government has been shoveling jobs away half as fast.

This is a major ingredient of my long term forecast that American GDP growth has permanently downshifted from the 3.9% we saw from 2000-2009 to 2% for this decade. That is the harsh reality behind the chart below showing job gains during this recovery compared to those in years past.

As an investor and trader, you must know that the financial markets don't believe or understand this yet. Stay cautious and stay nimble, and for the time being, stay short.

-

June 6, 2011 - Charts Are Breaking Down All Over

Diary

Featured Trades: (CHARTS ARE BREAKING DOWN ALL OVER)

2) Charts Are Breaking Down All Over. My friends at StockCharts.com produced a wonderful series of charts today showing how destructive was the damage in risk assets, in general, and equities, in particular. The chip shot on the downside for the S&P 500 is now 1,260. With near panic among short term traders becoming endemic, we could hit that number very quickly. Furthermore, the long term trend line that has been supporting the bull market for 26 months is now at risk.

Also, take a look at the chart for the junk bond ETF (HYG), which is breaking down in a major way. You may recall that I argued that this asset class was also wildly over valued and due for a major round of selling (click here for 'Take a Ride in the New Short Junk ETF'). Those who followed my advice to buy the short junk bond ETF (SJB) have profited nicely, while the rest of the world has been going to hell in a hand basket.

Keep in mind that these are only charts, and that their utility has been somewhat diminished by the high frequency traders that now dominate the marts. But they do seem to be lining up nicely with my watershed piece that I published on April 22, 'Meet the 'RISK OFF' Portfolio' (click here for the piece)

-

The Breakdowns Are Everywhere

June 6, 2011 - The Economic Headwinds Are Coming

Diary

Featured Trades: (THE ECONOMIC HEADWINDS ARE COMING)

3) The Economic Headwinds Are Coming. Whenever someone is dead right about the long term outlook for the economy, I like to revisit their comments. So am once again running a conversation I had with my friend, David Hale, a month ago, back when investors were stumbling over each other to pile on risk assets, and the indexes were hitting new highs for the year daily.

I have followed David Hale's prognostications about the global economy for two decades, and have always found his views insightful, if not useful. Although based in Chicago (click here for his site), he is almost permanently on the road, consulting with foreign governments, major banks, and big hedge funds.

He called me recently while driving a rental car to some godforsaken Midwestern airport, holding a GPS in one hand, a cell phone in the other, and steering the wheel with his knees, to give me his current take. It is not a pretty picture.

The end of QE2 and Obama's many stimulus programs are about to create a major drag on the US economy. On top of this you have to consider the likelihood that the Bush tax cuts will not be renewed a second time. You can also take out the deflationary impact of high oil prices. Add it all up, and you come up with a negative 5% headwind in annualized GDP hitting at the beginning of 2012. Although the sedentary, Harris tweed jacket wearing David is not prone to making extremist, sensationalist comments, only one ugly word can come out of this: recession.

The bad news is that the markets don't know this yet. But they will. Using the traditional rule of thumb that equity markets lead the economy by about six months, that means you should start unloading your positions right about now.

The Economy is Facing Major Head Winds

June 6, 2011 - Here Comes the Rhodium ETF

Diary

Featured Trades: (HERE COMES THE RHODIUM ETF)

4) Here Comes the Rhodium ETF. Deutsche Bank has launched the first ever ETF for the precious metal Rhodium, to be listed on the London stock exchange. Expecting a massive inflow of capital into this obscure corner of the hard asset world, traders ran prices up 20% last week. ETF launches for platinum (PPLT), and Palladium last year had a similar effect on prices.

Rhodium is one of the world's hardest metals, and is used by the auto industry as a substitute catalyst for platinum and palladium. Like the other white metals, it therefore has twin demand for both industrial and investment purposes. About $2 billion a year worth of rhodium is mined, compared to $10 billion for platinum and $30 billion for silver. At $2,350 an ounce, rhodium is the most valuable of the precious metals, compared to gold (GLD) ($1542), platinum (PPLT) ($1,812), palladium (PALL) ($769), and silver (SLV) ($36). During the hard asset squeeze in 2008, rhodium reached an incredible $10,000 an ounce.

I'll be writing more about rhodium in the near future. When hard assets come back into vogue, this is something you want to keep on your radar. It has all the ingredients for a potential sharp appreciation; a tiny global supply and potentially insatiable demand.

-

June 3, 2011 - Here Comes the Double Dip

Diary

Featured Trades: (HERE COMES THE DOUBLE DIP), (TLT), (TBT), (JNK), (SJB)

1) Here Comes the Double Dip. With yields on ten year Treasury bonds piercing below the 3.00% level through to 2.95%, you now have to take seriously the possibility of a double dip recession. This is particularly concerning given that bond markets are usually right, and equity markets are usually wrong, when forecasting the future direction of the economy. That makes stocks look especially expensive right here.

Look at the chart below to see that the ETF long dated bonds (TLT) has rallied a full ten points since I made my bullish call on fixed income in March. This was not an easy call to make, as the consensus then was for a coming collapse of Treasury bond prices in the run up to the end of QE2.

It was such a bold call that others talked me into keeping the position small, always a big mistake. As hedge fund legend George Soros taught me, 'Anything worth doing is worth doing big.' The chart for the (TLT) is now starting to resemble that for silver a month ago. You would be mad to initiate new longs here.

Which brings me to the chart for the inverse long dated Treasury short ETF (TBT). No security has been taken out to the woodshed and spanked more severely, falling 24% since its February peak. I made a killing in the (TBT) in December, nimbly stepped out in January, and never went back. The (TBT) has a double burden here, since as a -2X leveraged fund you are short twice the coupon on the underlying bonds. That takes the cost of carry to a hefty 7% a year, more than 50 basis points a month, down from the 9% we saw at the beginning of the year. When it gets to 6%, last year's low, call me.

There is one corner of the fixed income universe that continues to pique my interest. If stocks fall, junk bonds will not be far behind, as these issuers are least able to cope with the blunt force of another slowdown in the economy. They are historically very expensive, with spreads over Treasuries at all-time lows. That makes the newly issued short junk ETF (SJB) especially interesting.

-

Is the Double Dip Coming?

June 3, 2011 - My Big Miss of the Year

Diary

Featured Trades: (MY BIG MISS OF THE YEAR), (FXF)

2) My Big Miss of the Year. If you had to name one asset that has benefited from every macro trend under the sun this year, it has to be the Swiss franc. No matter what happened, be it the coming Greek default, the European banking crisis, the Japanese tsunami, the Libyan Civil War, the commodity collapse, and now the slowing US economy, all seemed to trigger kneejerk buying of even more bushels of Swiss francs.

Switzerland is certainly a country with many attractions. The economy is healthy, with the most recent retail sales up 7.5% and unemployment at an enviable 4.2%. It is home to several world class companies, like, Nestle, Roche, Novartis, and Swatch. It has perennially run a strong current account surplus. Its 347 banks control assets amounting to seven times the country's GDP, and account for 40% of stock market capitalization (compared to 9% in the US). Despite shunning membership in the European Community, it has developed a world class export industry in heavy and precision machinery, pharmaceuticals, and high quality textiles. It is not all about watches, cheese, and Swiss army knives.

None of this explains why the Swiss franc has been so strong. Since the beginning of the year, the currency has soared by 17% to 85 centimes to the dollar. Note that the ETF (FXF) is priced in the inverse to the cash market, meaning that it takes $1.17 to buy one Swiss franc. To give you some long term perspective on this, the dollar is now 72% cheaper than when I first visited this alpine paradise 43 years ago, when is cost SF3.00 to purchase a greenback.

As strong as the fundamentals are for Switzerland, they have nothing to do with the strength of the currency. It has become the flight to safety currency of choice for Europeans. This is not a new development. While a director of Swiss Bank Corporation, I personally saw gold bars imprinted with the German eagle secreted there by high ranking Nazi's and never reclaimed. This is one theory why the Germans didn't invade Switzerland during WWII.

Later, asset protecting investors believed that the Swiss Army's formidable mountain redoubts could hold the Soviet army at bay. To this day, there are still formidable stockpiles of weapons in the basements of the big Swiss banks, and many of the senior staff double as army officers.

One reason the Swiss franc has been a speculative target is that the country has a Lilliputian GDP of $642 billion, only 4.4% of America's. The tide of money into the franc has been so large that the Swiss can do little to stop it. The Swiss National Bank has lost billions of dollars buying euros and selling francs to slow the ascent, losing billion in the process, on paper anyway.

I missed this whole move this year because I focused on the country's fundamentals, which are quaint but irrelevant in the global scheme of things, and not the capital flows. It is clear that the latter is overwhelming the former. And concluding that capital flows are now the driver, you can cobble together an argument that the move is coming to an end. We have seen the early stirrings of what could be a global, 'RISK OFF' move into the dollar. Once it gets up a decent head of steam, it would not be a stretch to see this spill into the Swiss currency as well.

I'm not saying you should sell short the Swiss franc here, but the bull move is certainly getting long in the tooth, and could suddenly die of a heart attack. As for my miss, I shall be punished severely when I visit Switzerland in a few weeks for a round of mountain climbing and have to pay through the nose for my fondue, russet potatoes, raclette, and schnapps.

-

Switzerland is Looking a Little Toppy to Me