April 28, 2009

1) There is something wrong with this picture.?? The Chinese stock market is shouting at us that the bull market is back, while the price of crude is telling us in more surreptitious tones that this is a bear market rally that will fail. If we were in a true economic recovery, crude would have run back up to the $70-$90 range by now. Who is right? Certainly large scale Chinese buying of economically sensitive commodities like crude and copper has been the hallmark this seven week move in global equity markets, which have brought a welcome $7 trillion boost in valuations. But how much of the move has been mere short covering? What is the extent of the dead can bounce? Until a recovery in corporate earnings signals the 'all clear' we could be stuck in a trading range here, possibly until the end of the year, and maybe for years. 'Sell in May and go away' is looking better by the day. Sell a few short dated calls above the market against your long positions. Pass the sunscreen?

2) Here are a few statistics about SARS (severe acute respiratory syndrome), also known as 'yellow pneumonia', the last pandemic fear that jolted the markets. In 2003, some 800 died in 25 countries, with an economic impact of $40 billion on the world economy. Then, like now, the press heralded this as the next Spanish flu. Instead it petered out in a few months. The market nearest epicenter of the crisis in China's Guangdong province, the Hang Seng, fell 25% to 9,000. I doubt this bug is going to be anywhere near as severe.

3) IBM has made public an excellent report on the long term future of the financial industry, one of its largest customers. The survey of 2,750 firms concludes that the age of extreme risk taking and huge bonuses is over. The high returns of the past, which thrived on the opacity of financial products, are history. Their guess is that profit margins will drop from an average 26% to 14%. Lower margins will be more sustainable. Long term compensation will be linked to long term gains, not short term profits. The government is going to mandate capital and liquidity cushions. Product sophistication outstripped investors' ability to manage, or even understand inherent risks. Up to 88% of past profits came from off exchange, over the counter trades that never saw the light of day. The easy money will be commoditized as the business is moved on to listed exchanges. Large hedge funds with easily replicated strategies will be under extreme pressure. It's an insightful report with more than a ring of truth which you should get your hands on.

4) With the lumber industry approaching its fifth year of what is nothing less than the Great Depression II, you'd think that this is the last place that futures traders would want to play. Prices for this commodity are driven primarily by housing starts, which have been in a death since 2006. No surprise then that lumber futures have plummeted from 70%, from $4.60 to $1.38 a contract, the lowest in 30 years. By the time you add up inventories of developers like Centex (CTX), Lennar (LEN), and Pulte (PHM), bank repossessions, and a gigantic overhang of anxious sellers desperately trying to get out of homes they can no longer afford, the number of houses for sale probably exceeds 5 million, or 8% of the total housing stock in the US, the most in 70 years. But the market thinks otherwise. The lumber industry has been downsized down to the bone through bankruptcies, mill closures, and distress inventory sales. So guess what happened in February when the trade never thought anyone would ever buy a stick of wood again? The Chinese showed up out of the blue as major buyers, triggering the ritual short covering rally, and chalking up two back to back limit up days in the futures market. Russia provided an assist by raising the tax on its lumber exports from 25% to 90%. Prices have recently settled at $1.85. I'm not by any means calling an end to the real estate crisis here, but lumber has suffered enough, and is a bargain. Smaller funds might consider using dips to accumulate longs. One futures contract get's you 110,000 board feet of 2' X 4' soft spruce, fir, and pine in mixed 8' to 20' lengths, worth $20,350, about two thirds of a rail car full. With a maintenance margin requirement of only $1,650, the contract gives you 12:1 leverage. It's a way to play the global demand for lumber without being held back by the continuing stress in American housing. If you don't need the leverage, look at the biggest producers, Weyerhaeuser (WY), Rayonier (RYN), or Louisiana Pacific (LPX) which have already had huge moves. After seeing similar Chinese moves in copper, crude, and coal, this could be further proof of the beginning of a much broader, long term bull market in commodities.

QUOTE OF THE DAY

When comparing working with Presidents Obama and Bush, House Speaker Nancy Pelosi said 'having a great intellect saves a lot of time.'