Gold is Making a Comeback

One of my best calls of the year was to plead with readers to avoid gold like the plague, periodically dipping in on the short side only. The barbarous relic has been in a bear market since it peaked at $1,922 an ounce at the end of August last year. Gold shares have fared much worse, with lead stock Barrack Gold (ABX) dropping 36% since then and the gold miners ETF (GDX) suffering a heart rending 43% haircut.

However, the recent price action suggests that hard times may be over for this hardest of all assets. Despite repeated attempts, the yellow metal has failed to break down below the $1,500 support level that I have been broadcasting as the line in the sand.

It has rallied $100 since the last try a few weeks ago. (GDX) has performed even better, popping 23%. For the last month, the entire precious metals space has traded like it was a call option on global quantitative easing (see yesterday?s piece). Dramatically worsening economic data is increasing the likelihood of further monetary easing generating a nice bid for gold.

Now the calendar is about to ride to the rescue as a close ally. It turns out that in recent years, there has been a major seasonal element to the gold trade, almost as good as the November/May cycle that drives the stock market. Gold typically sees a summer low. Then traders start anticipating the September Indian gold season when the purchase of gifts and dowries become a big price driver. That explains why India, with a population of 1.2 billion, is the world?s largest gold buyer.

Next comes the Christmas jewelry buying season in western countries. That is followed by the gift giving and debt repayments during the Chinese Lunar New Year, during which we see multi month peaks in the yellow metal. That is exactly what we saw this year. The only weakness in this argument is that a slowing Chinese economy could generate less demand this time.

These are heady inflows into such a small space. All of the gold mined in human history, from King Solomon's mines, to the bars still in Swiss bank vaults bearing Nazi eagles (I've seen them) would only fill 2.5 Olympic sized swimming pools. That amounts to 5.3 billion ounces, about $8.6 trillion at today's prices. For you trivia freaks out there, that is a cube with 66 feet on an edge. China is the largest producer (13.1%), followed by Australia (10%) and the US (8.8%).

Peak gold may well be upon us. Production has been falling for a decade, although it reached 94 million ounces last year worth $153 billion at today?s prices. That would rank gold 5th as a Fortune 500 company, just ahead of General Electric (GE). It is also only .38% of global public debt markets worth $40 trillion.

That is not much when you have the entire world bidding for it, governments and individuals alike. Talk about getting a camel through the eye of a needle! We may well see the bull market end only when those two asset classes, government bonds and gold, see outstanding values reach parity, implying a major increase in gold prices from here. That is well above my own personal target of the old inflation adjusted high of $2,300. No wonder buying is spilling out into the other precious metals, silver (SLV), platinum (PPLT), and palladium (PALL).

The thumbnail technical view here is that we have broken the 50 day moving average at $1,610, so we may have a clear shot at the 200 day average at $1,680. There may be an easy $50 here for the nimble, and more if we break that. The current ?RISK ON? mood certainly helps this trade.

When playing in the gold space, I always prefer to buy the futures or the (GLD), the world?s second largest ETF by market cap, either outright or through a longer dated call spread. The dealing costs are far too high for trading physical bars and coins, and can run as high as 30% for a round trip. Having spent 40 years following mining companies, I can tell you that there are just way too many things that can go wrong with them for me to risk capital. They can get nationalized, suffer from incompetent management, hedge out their gold risk, get hit with strikes or floods, or get tarred by poor equity market sentiment. They also must endure the highest inflation rate of any industry, around 15%-20% a year, which hurts the bottom line.

Better just to stick with the sparkly stuff.

 

 

 

 

 

 

 

It?s Time to Start Dabbling in Gold Again

Greek Conservative Win Sends Shorts Fleeing

The victory of the centrist pro bailout New Democracy Party in the Sunday Greek elections sparked a furious rally in the overnight Asian markets, much of it driven by hedge fund short covering. The socialist, anti-bailout parties went down in flames. As I write this on Sunday night, the Dow futures are trading up 78 points from the Friday close and the Japanese yen is in free-fall. Too bad that I?m 110% long ?RISK ON? positions in my model portfolio.

That was no surprise as 70% of Greeks want to stay in the EC. The way is now paved for a more civilized workout of the country?s financial problems which spreads austerity out over many more years, making it more tolerable and digestible for its citizens.

The latest Commitment of Traders report showed the Euro (FXE) (EUO) shorts in the futures hit yet another all-time high, and that the underlying was now worth $20 billion in the foreign exchange market. Shorts in the interbank cash market and ETF?s are thought to be much larger. On top of that, central banks have been seen unloading reserves denominated in Euros.

This witches brew of one-sided positions made up the perfect ingredients for the type of rip-your-face-off, snap back short covering rally that we have seen in past days. This is why I covered my own shorts three weeks ago when it pierced the $126 handle.

Keep in mind that the media has a lot of blood on its hands with its wild over exaggeration in its predictions of the imminent collapse of Greece and its withdrawal from the European Community that was never going to happen. It is focusing 99% of its attention on the Land of Socrates and Plato that accounts for 1% of European GDP. In the meantime, it is ignoring Germany which has 30% of GDP and is still growing, albeit at a slower 1% rate.

CNBC, in particularly, seems to be mercilessly beating this dead horse, holding it out as an example of what will happen to the US if it pursues similar high spending polices. This is why they send a Tea Party activist out to Athens at great expense every week to provide your coverage and to bait the Socialist candidates. They haven?t been this wrong since they reported that the Facebook issue was 30 times oversubscribed in Asia the night before it became the worst IPO in history.

But Greece has about as much in common with America as the US Treasury has with the bankrupt city of Vallejo, California. If anything, Greece is a perfect example of what happens when the wealthy get away with paying no taxes. Anyone with substantial means there stashes their dosh in Swiss bank accounts, leaving only the poor to cough up government revenues. Rich Greeks are just better at it than Americans. After all, they have been practicing for 5,000 years.

Greece is so small that it would be economic for Germany to just pay off half of its national debt just to maintain stability for its largest export markets. Should they spend $270 billion to protect $1.27 trillion in annual exports? It makes sense to me.

And let me give you a little back story here which you probably haven?t heard. Where did all this debt come from? Greedy unions? Careless bureaucrats? Spendthrift socialists? Expensive national health care?? A very big chunk was the result of the 2004 Athens Olympics where the government spent billions on huge sporting facilities and infrastructure that would only be used once and that it could never afford. Who constructed these massive edifices? German engineering firms. I know because I was there. There is always more to the story than the headline.

I hope my guests at my upcoming July 18 Frankfurt strategy luncheon don?t tar and feather me, or whatever they inflict on miscreants there, for expressing this opinion.

All of this is leading up to a great shorting opportunity for the beleaguered European currency. Given the current positive background, it could make it all the way back up to $127.80. That is a neat 50% retracement of the recent move down from $132.80 to $123.00. But be careful not to fall in love with it. The major trend in the Euro is still down, aiming for $1.17. And with a 0.50% interest rate cut by the European Central Bank imminent, that target could be hit sooner than later.

 

 

 

 

Don?t Fall in Love With the Euro

Be Careful What You Wish For

The wild whipsaw movements in the markets on Thursday reminded us once again how dependent they have become on monetary stimulus from central banks. As if we needed reminding. Almost simultaneously, officials from the US, Japan and the UK hinted at a coordinated move at this weekend?s G-20 meeting in Cabo San Lucas, Mexico.

Let?s hope for the sake of global financial stability that no one eats a bad taco down there. And say ?Hello? to Miguel for me at the notorious drinking establishment, The Giggling Marlin. Just make sure he doesn?t pick your pocket when he hangs you upside down by your ankles with a block and tackle to give you a tequila shot.

The rumors were enough to cause me to cover my sole remaining short position in the S&P 500 (SPY) and bat out some additional shorts in the Japanese yen, which would go into free fall in such a scenario. If the rumors are true, they will take the (SPX) up to 1,400 and I will make a killing on my hefty long positions in (AAPL), (HPQ), (JPM), (DIS) and shorts in (FXY) and (TLT). If not, then the large cap index will revisit 1,290 one more time and I will be left looking like a dummy while posting an embellished resume on Craig?s List.

To see how closely risk assets are correlated with quantitative easing, take a look at the chart produced below by my friend, Dennis Gartman of The Gartman Letter. It graphically presents the market response to QE1, QE2, and Operation Twist, which are highlighted in green. In fact, quantitative easing has become the on/off switch of the financial markets. Hence, we get ?RISK ON?/?RISK OFF? gyrations in spades.

While on the topic of monetary policy, let?s consider the implications of a Romney win in the November presidential election. The former Massachusetts governor and son of a Michigan governor has said that he would fire Federal Reserve Governor, Ben Bernanke, on his first day in office.

Well, he actually can?t do that, although it is great fodder for the faithful on the hustings. What he can do is appoint and anti QE, pro-austerity replacement when Ben?s second four year term is up on January 31, 2014. At the top of the list of replacements are Stanford University?s John Taylor of Taylor Rule fame and sitting non-voting board member, president of the Dallas Fed, and noted hawk, Richard Fisher.

How would the financial markets react? Much of the recent buying of stocks and other risk assets has been on the assumption that the ?Bernanke Put? would kick in on any serious selloff. No Bernanke means no Bernanke put. I can already hear portfolio managers thinking ?What, you mean there is risk in these things?? and heading for the exits as quickly as possible. The resulting market crash could make 2008-2009 look like a cakewalk. Your 401k would rapidly shrink to a 201k, and your IRA would become DOA. So be careful what you wish for.

That is unless you are a reader of this letter and a subscriber to my Trade Alert Service. Such a market meltdown would be one of the great shorting opportunities of the century. But to follow the game you have to have a program.

 

 

 

 

 

 

Time for Another Shot of Monetary easing

The Nationalization of the Bond Market

I was as stunned as anyone when the yield on the ten year Treasury bond (TLT), (TBT) plummeted to 1.42% two weeks ago. Predictions that long dated government paper would reach subterranean Japanese levels, considered loony as recently as a few months ago, are now donning the mantle of respectability, and even plausibility. Where will this end? With yields at 1.25%, 1%? 0.50%?

As with any ground breaking, epoch making, even cataclysmic change in the fundamental structure in the global financial markets, I searched for the reasons why I didn?t see this coming. How could I be so wrong? What did I miss? I haven?t been this far off base since the term ?blue dress? entered the political lexicon.

Then I looked at the recent ownership of the Treasury bond market and the answer was so obvious that it practically lifted me up by the lapels of my Brioni jacket and shook me until the gold inlays fell out of my teeth. The implications for international finance are huge, and are even bigger for your own net worth.

It turns out that governments have been steadily taking over the global bond market, not just Uncle Sam, but all major countries that have been pursuing quantitative easing. As a result, private ownership of Treasury bonds has shrunk from 55% thirty years ago, to only 23% today. Foreign holders, primarily central banks, have increased their portfolios from 13% to 34% during the same period. The Federal Reserve?s ownership of the Treasury market has soared from 5% to 11% since 2012, thanks to QE1, QE2, and the twist policy.

Therein lays the problem. Governments aren?t like you and I. They are the ultimate ?dumb money?. Once they buy a bond, they don?t care what the price is. They just carry it on their books at face value. They don?t need to mark to market. When debt matures, they just roll it over into similar issues. If you or I tried this, we would go to jail, and possibly even share the same cell.

The bottom line on all of this is that governments are uneconomic, irrational, and even price insensitive buyers. If the price goes up they don?t care. They also don?t do what the rest of us do when prices spike, as they have done, and that is sell. That?s because they don?t have clients like we do. This has created an unnatural market where the demand for government paper is nearly limitless, and the supply is inadequate.

Using this analysis, the big surprise is not that ten year yields hit 1.42%, but that they took so long to get there. This also suggests that bond interest rates will stay unbelievably low far longer than anyone realizes, possibly for years more.

There is another angle to this, which the pols on Capitol Hill failed to recognize. As a result of the new Dodd-Frank financial regulation bill, many derivatives contracts will become marginable for the first time. With the aggregate amount of such contracts estimated at $700 trillion, even just a minimal 1% collateral requirement would automatically create $7 trillion in potential Treasury paper buying.

That is little less than half the current $15 trillion national debt. In fact, it was massive government mandated bond buying in Japan just like this that kept interest rates so low there for so long. I know because I have written three books on this topic.

Much of the current political debate revolves around the belief that the US government is borrowing too much money. But the markets are screaming at us that the complete opposite is true. It is not borrowing enough. There is in fact a global savings glut and bond shortage that looks to get worse before it gets better. As for the monstrous, untamable inflation that such high levels of borrowing created in the past, like the Loch Ness Monster, the Yeti, and Bigfoot, and I?ll believe it when I see it.

 

 

Look, There Goes Inflation

The Next China Boom

The call was scratchy and barely audible. I was instructed to not mention any names. I should only use the prearranged code words when talking about political parties. You never know when the phones in China are tapped. I was just about to get a heads up that the People?s Bank of China was going to lower interest rates for the first time in four years.

Of course, we knew this was coming. Three relaxations of bank reserve requirements over the past six months telegraphed that the Middle Kingdom?s economy was slowing and that some serious monetary easing was on the way. But it appears that the things were now starting to get out of hand, possibly taking the GDP growth rate below the government?s 7% target.

Chinese companies were canceling contracts to buy imported commodities left and right, including for corn, sugar, copper, and iron ore, causing much distress among foreign counterparties. Now we learn that there are two dozen ships sitting off the Chinese coast fully loaded with coal, with no takers. The Chinese are walking away from contracted deliveries and refusing to pay, much as they did at the height of the 2008 financial crisis.

The really fascinating point that my friends in Beijing were trying to hammer home is that the current round of weakness is setting up the buying opportunity of the century. China is in the midst of changing government for the first time in a decade. The new president, Xi Jinping, is expected to take power in March, 2013, and will owe a broad range of constituents favors for his successful ascent. To solidify his position he will engineer a broad rise in the country?s standard of living that will benefit everyone in the country.

The first order of business will be to clean house and install loyal cadres across the upper tiers of the bureaucracy. Then he will launch a massive stimulus package designed to accelerate the growth of the domestic economy and wean the country off of its dependence on low waged export industries. The goal will be to move the Middle Kingdom?s economy inland, away from the coast where it is now concentrated.

That will enfranchise more of the 400 million of the rural population who have yet to participate in the modern economy and enjoy its benefits. The ultimate goal will be to raise Chinese per capita incomes from the current $3,000 to the $10,000-$20,000 range. A spin off advantage of this policy will be that it improves relations with the US, which until now has been drowning in Chinese exports in many politically sensitive industries. The economy will boom.

To finance this effort, the government will embark on a large scale privatization of state owned assets. Targeted is the government?s ownership of wide swaths of the banking, insurance, railroad, telecommunication, and energy industries. The effort will mirror the privatization policy that Margaret Thatcher imposed on the United Kingdom from the early 1980?s and the one the Japanese initiated a few years later. I participated in both, and the trading profits I took in were more than generous.

The funds that the Mandarins in Beijing will raise from this campaign will be used to pay off its enormous domestic debts. It will also be spent on repairing China?s badly tattered social safety net, with huge expenditures earmarked for health care and social security.

Stock markets will enjoy a major bull market for a decade, both in China (FXI), surrounding Asian emerging nations, like South Korea (EWY), Taiwan (EWT), Thailand (TF), Indonesia (IDX) and in Australia (EWA). Their currencies will rocket too, including The Australia (FXA), Singapore, Hong Kong, and Taiwanese dollars, as well as the Korean won.

The industry plays here won?t be the big infrastructure ones that worked so well in the last bull market, but instead will be focused on the country?s nascent consumer sector. I obviously need to do more work in this area, and when I get specific names, I will let you know.

Investments made near the current lows should see tenfold to twentyfold returns in coming years. This will also pave the way for full convertibility of the renminbi which could lead to the same sort of 300%-400% appreciation that we saw with the Japanese yen from the 1970?s to the 1990?s. That will create a double leveraged, hockey stick effect on the profits on Chinese investments.

What all of this does is to keep the Chinese economy growing at a 6%-8% rate for the indefinite future. While this is a slower rate than seen in years past, it will be off a much larger base, so the impact on the global economy will be substantial. China now boasts the world?s second largest economy, with GDP at $5.5 trillion, still well behind the US at $14.5 trillion.

Needless to say, basic commodities, like copper (CU), coal (KOL), iron ore (BHP), (RIO), all the food plays (CORN), (WEAT), (SOYB), (POT), (MOS), soar in this scenario. Gold (GLD), silver (SLV), platinum (PPLT), and palladium (PALL) also do extremely well. This could be the base case for taking the yellow metal up to my long term target of $2,300 an ounce, or even to the gold bug levels of $5,000 to $10,000.

So when does my friend expect the greatest bull market of all time to begin? After the new government comes in next March you should allow six months for it to get settled and get its ducks lined up. That takes us out to October, 2013. Until then the stock market will continue to bump along the bottom, as we have seen for the past year. Of course, if the markets get a whiff of what?s coming, they could react much sooner. You can take the China crash scenario and throw it in the trash.

I asked my contact if the demographic wall that I expect China to hit in five years will cool his expectations. This will happen with the population pyramid inverts as a result of its 32 year old one-child policy, and a large aging population supported by a smaller generation of young workers creates a large economic drag. He said that demographic effects won?t really impact the financial market for ten years, and could well be what brings the next bull market to an end.

 

 

 

 

Buy the Next Low

Reach for Yield With Master Limited Partnerships

The dramatic collapse in the price of oil is creating a rare opportunity to get into some of the highest yielding paper in the financial markets, master limited partnerships (MLP)?s. These are LP?s that are publicly traded on a securities exchanges. These unique and versatile instruments combine the tax benefits of a limited partnership with the liquidity of publicly traded securities.

Enbridge Energy Partners (EEP) is run by some of my former colleagues at Morgan Stanley and offers a 7.5% yield. Kinder Morgan Energy (KMP) posts a healthy 5% yield, while Trans Mountain (TLP) ups the ante with an 8% return. Linn Energy goes all the way up to an eye popping 8.5% yield.

Why the enticing cash flow? The problem is that these partnerships suffer from their guilt by association with Texas Tea, which has plummeted by nearly 30% since March 1. Although they have no direct exposure to the price of oil, investors tend to incorrectly classify them as energy stocks and dump them whenever oil falls. The great thing about these high yields is that you get paid to wait until crude makes a comeback, which it always does. Not a bad game to play in a zero return world.

To qualify for MLP status, a partnership must generate at least 90 percent of its income from what the Internal Revenue Service deems "qualifying" sources. For many MLPs, these include all manner of activities related to the production, processing or transportation of oil, natural gas and coal. Energy MLPs are defined as owning energy infrastructure in the U.S., including pipelines, natural gas, gasoline, oil, storage, terminals, and processing plants. These are all special tax subsidies put into place when oil companies suffered from extremely low oil prices. Once on the books, they lived on forever.

In practice, MLPs pay their investors through quarterly distributions. Typically, the higher the quarterly distributions paid to LP unit holders, the higher the management fee paid to the general partner. The idea is that the GP has an incentive to try to boost distributions through pursuing income-accretive acquisitions and organic growth projects.

Because MLPs are partnerships, they avoid the corporate income tax, on both a state and federal basis. Instead of getting a form 1099-DIV and the end of the year, you receive a form K-1, which your accountant should know how to handle. Additionally, the limited partner (investor) may also record a pro-rated share of the MLP's depreciation on his or her own tax forms to reduce liability. This is the primary benefit of MLPs and gives MLPs relatively cheap funding costs.

The tax implications of MLPs for individual investors are complex. The distributions are taxed at the marginal rate of the partner, unlike dividends from qualified stock corporations. On the other hand, there is no advantage to claiming the pro-rated share of the MLP's depreciation (see above) when held in a tax deferred account, like a IRA or 401k. To encourage tax-deferred investors, many MLP?s set up corporation holding companies of LP claims which can issue common equity.

Since 2003, MLPs as an asset class have grown astronomically, from $30 billion to $250 billion , and have also been the best performing asset class in the world over the last 10, 5, and 3 year periods. The recent discovery of new, massive gas and oil fields in the US and the rapid expansion of shale fracking should auger well for the rising popularity of this instrument.

 

 

 

 

 

 

Nope, Don?t See Any Yield Yet

Nonfarm Bombshell Sends Markets Scampering

Say goodbye to 2012. That was the harsh conclusion of the marketplace after the release of the devastating May nonfarm report that forced the Dow to give up its entire year to date performance.

The cat was really set among the pigeons this morning when the Department of Labor informed us that only 69,000 jobs were gained in the previous month. The unemployment rate ratcheted up to 8.2%. ?RISK OFF? returned with a vengeance, sending stocks, commodities and oil into a tailspin. Bonds roared, the ten year Treasury reaching the unimaginably low yield of 1.42%. Japanese style bond yields here we come.

The truly horrific numbers were the revisions, which saw the jobs figure for March cut by -11,000 and April by -38,000. The biggest gainers were in health care (+33,000), transportation and warehousing (+33,000), and manufacturing (+12,000). The losers were in construction (-28,000), government (-13,000), and leisure and hospitality (-9,000). The long term unemployment rate jumped from 5.1 million to 5.4 million. The inexorable trend of a shrinking government and a growing private sector continued.

Administration officials made every effort to put lipstick on this pig, and were at pains to point out that this was a seasonal slowdown that occurs every year. The operative word here is that jobs were ?added?. They argued that the real focus should be on the 4.3 million private sector jobs created in the last 27 months. The markets didn?t buy this glass half full interpretation for a nanosecond.

Of course, further talk of quantitative easing came to the fore once again, preventing an even bloodier sell off, forcing traders to keep a hair trigger on their shorts. From here on, the government is going to attempt to make life as uncomfortable as possible for short sellers who are seen to be restraining the grand design. As I always tell traders in these conditions, make the volatility work for you and run towards it, not against it.

Don?t expect the Federal Reserve to rise to the rescue of risk assets anytime soon. It has so little dry powder left that it is unlikely to move until market conditions dramatically worsen. My bet is that the Fed won?t take action until the S&P 500 hits 1,100. The problem is that we may get our wish.

Looking at the charts below, you can only conclude that there is more pain to come. Commodities, the first asset class to enter this selloff, look like they will be the first to hit bottom. Oil (USO) is at my downside target of $85, copper (CU) is rapidly approaching my $3.00/pound goal, and gold (GLD) keeps bouncing off of my $1,500 floor.

Since equities were the last to top, they may become the last to bottom. Therefore, I think we may be two thirds of the way through this downturn on a price basis, but only half way on a time basis. That analysis sees a new major rally postponed until August at the earliest. It also made 1,250 the next stop on the downside and 1,250 an obvious medium term target.

For those who took my advice to sell in May and go away, good for you. Go blow your profits on a vacation in the Hamptons this summer. And have a mojito for me.

 

 

 

 

 

Are We Probing a Bottom With Housing?

The March Case Shiller Home Price Index is out, showing that the fall in home prices continues unabated, paring -2.6% on a YOY basis. Detroit delivered the biggest drop, down a shocking -4.4%, followed by Chicago (-2.5%), and Atlanta (-0.9%). But 14 out of 20 markets managed increases in prices. The national index is still declining, but at a slower rate. Given that this indicator lags real time by about three months, is there something going on in housing that we should be anticipating?

Don?t get your hopes up and rush out and place a deposit on a new home. I think that the strength that we are seeing may be only a short term anomaly of the marketplace. So much hedge fund and private equity money poured into the foreclosure market recently that we suddenly ran out of inventory. Up to 60% of recent home sales have been in the foreclosure area. This explains the sudden pop in the average cost of homes sold.

These funds have set up local management companies to rent out properties and are soaking up 1,000 homes at a throw, looking to sit on them for a decade until the demographic headwind turns to a tailwind. They are encouraged by negative real interest rates, the 30 year mortgage now plumbing an unbelievable 60 year low of 3.75% that made this investment a no brainer for the patient and deep pocketed. The goal is to eventually securitize these holdings and sell them for a premium.

We are not by any means out of the woods. Pending home sales plunged by 5.5% in April, and March was revised down sharply. The west showed the steepest decline, down 12%. The banks also have a seemingly limitless ability to produce new foreclose inventory.

The demographic headwind is still at gale force strength, as 80 million baby boomers try to sell houses to 65 million Gen Xer?s who earn half as much money. Don?t plan on selling your home to your kids, especially if they are still living rent free in the basement. There are six million homes currently late on their payments, in default, or in foreclosure, and an additional shadow inventory of 15 million units. Access to credit is still severely impaired to everyone, except, you guessed it, the 1%. Many deals fall out of escrow at the last minute over appraisal issues which fail to meet the banks? new, more demanding requirements.

I think the best case that can be made for housing here is that we may finally be coming into an uneasy balance that sets up a bottom for prices which we will bounce along for five to ten more years. This has been made possible by the arrival of an entire new class of buyers, the opportunistic hedge funds.

 

 

 

 

 

 

 

My Tactical View of the Market

The abject failure of the equity indexes to breach even the first line of upside resistance does not bode well for the ?RISK ON? trade at all. Only a week ago I predicted that the markets would be challenged to top 1,340 in the (SPX) and $78 for the Russell 2000 (IWM). In fact, we made it up only to 1,335 and $77.90 respectively.

To see the melt down resume ahead of the month end window dressing is particularly concerning. That?s the one day a month that investors really try to pretend that everything is alright. People just can?t wait to sell.

Blame Europe again, which saw Spanish bond yields reach a 6.6% yield on the ten year and the Italian bond market roll over like the ?Roma? (a WWII battleship sunk by the Germans while trying to surrender to the Allies). Facebook didn?t help, knocking another $8 billion off its market capitalization, further souring sentiment.

Urging traders to head for the exits was confirming weakness across the entire asset class universe. The Euro is in free fall. Copper took a dive. Oil is plumbing new 2012 lows. Treasury bond prices rocketed, taking ten year yields to new all-time lows at 1.65%. It all adds up to a big giant ?SELL!?

It is just a matter of days before we revisit the (SPX) 200 day moving average at 1,280. Thereafter, the big Fibonacci level at 1,250 kicks in. It is also exactly one half the move off of the October 2011 low, and unchanged on the year for 2012.
I am not looking for a major crash here a la 2011. There is just not enough leverage and hot long positions in the system to take us down to 1,060. It will be a case of thrice burned, four times warned. And remember, last year?s 1,060 is this year?s 1,100, thanks to the earnings growth we have seen since then. With 56% of all S&P 500 stocks now yielding more than the ten year Treasury bond, you don?t want to be as aggressive on the short side as in past years, when bond yields were 4 or higher.

By adding on a short in the (SPY) here, I am also hedging my ?RISK ON? exposure in the deep in-the-money call spreads in (AAPL), (HPQ), and (JPM), and my (FXY) puts. The delta on these out-of-the-money?s are so low that I can hedge the lot with one small 5% position in the at-the-money (SPY) puts.

If the (SPX) hits 1,280, the (SPY) puts will add 2.25% to our year to date performance. At 1,250 we pick up 4.00% and at 1,200 we earn 7.00%. I now have the option to come out at any of these points if the opportunity presents itself, depending on how the rapidly changing global macro situation unfolds. If we get another pop from here back up to the 1,340-1,360 range, I will double up the position and swing for the fences. There?s no way we are taking a run at new highs for the year from here.

Below, find today?s charts from my friends at www.StockCharts.com with appropriate support and resistance levels outlined. If I may make another observation, when you see the technicals work as well as they have done recently, it is only because the real long term end investors have fled. There are not enough cash flows in the market to overwhelm even the nearest pivot points. That leaves hedge fund, day, and high frequency traders to key off of the obvious turning points in the market. That also is not good for the rest of us.

 

 

 

 

 

It?s a good thing that I?m not greedy. If I had sold short a near money call spread for the (TLT) on May 23, I would be in a world of hurt right now. Instead, I went six point out of the money. So when we get dramatic moves like we saw today that take bond yields to all-time lows, I can just sit back and say, ?Isn?t that interesting.? This spread expired in six trading days, which should be enough time to digest the big move today and expire safely out of the money and worthless. What?s better, I can then renew the trade at better strikes after expiration into the July?s and take in more money.

If you are wondering why I am not doubling up on the short Treasury bond ETF (TBT) down here, it?s because it doesn?t have enough leverage. In these conditions you need to go for instruments that can generate immediate and large profits, such as through the options market. The topping process for the Treasury market could go on for another month or two. Until that ends, I am happy to use price spikes like today?s to sell short limited risk (TLT) call spreads 6-8 points out of the money, which can handle a 20 basis point drop in yields and still make you money.

If you own the (TBT) and are willing to take a multi month view, you should be doubling up here. This ETF will have its day in the sun, it is just not today. We could see the $20 handle again and maybe even $30 within the next year. That makes it a potential ten bagger off of today?s close.

 

 

 

 


I don?t want to touch gold (GLD) or silver here. The barbarous relic is clearly trying to base at $1,500 an ounce. If it fails, it will probably only go down to only $1,450 before major Asian central bank buying kicks in. Better to admire it from afar, or limit your activity to early Christmas shopping for your significant other. We are months away from the next major rally in the yellow metal.

 

 

The Roma

Time to Puke Out Again

 

Time to Buy JP Morgan

This is far and away the world?s premier banking institution. Estimates of the huge trading losses by the London ?whale?, initially pegged at $2 billion, have since skyrocketed to $6 billion. I?ll ignore the Internet rumors that speculate about a $30 billion hickey. As you well know, almost everything on the net is not true, except what you read in my own newsletter.

Back in the 1980?s when I was at Morgan Stanley, the inside joke was to look for nice office space for ourselves whenever we visited clients at (JPM). The expectation was that they would take us over when Glass-Steagle ended, as they were both the same institution before the Securities and Exchange Act broke them up in 933. When the separation of commercial and investment banking finally came in 1999, Morgan Stanley had grown far too big to swallow and the egos too big to manage.

I?ll tell you another way to look at this trade. (JPM) lost 4.7% of its capital, so Mr. Market chewed 30% out of its capitalization. Sounds a bit overdone, no? The bad news is already in the price. A large part of the offending position has already been liquidated.

I have known Jamie Diamond for a long time, and can tell you that he is the best manager of a financial institution anywhere. I have been warnings him for years that his traders were understating risk and leverage in esoteric derivatives in order to boost their own bonuses. It was just a matter of time before they blew up. Presumably, by now Jamie has tightened up internal controls and in the future won?t pay so much attention to presentations by wet behind the ears traders pitching schemes that are too good to be true. As a result, you can now buy (JPM) at the blow up price.

I have analyzed the specific trade that got (JPM) into so much trouble, the now infamous ?Investment Grade Series 9 Ten Year Index Credit Default Swap.? The chart of its recent performance and its hedge is posted below. It was in effect a $100 billion ?RISK ON? trade that came to grief in early May.

The trader involved, Bruno Iksil, broke every rule in the trading Bible: too much leverage in an illiquid credit derivative with no real risk control and hedges that were imprecise at best. As I never tire of pointing out to hedge fund newbies, when your longs go down and your shorts go up in a hedge fund, you lose money twice as fast as a conventional long only fund. Play at the deep end of the pool, but be aware of the risks.

Few outside the industry are aware that this was a $6 billion gift to two dozen hedge funds who are now shouting about record performance. It is, after all, a zero sum game. Didn?t Bruno get the memo to ?Sell in May and go away?? He obviously doesn?t read The Diary of a Mad Hedge Fund Trader either.

Even if the worst case scenario is true and the $6 billion numbers proves good, that only takes a 4.7% bite out of the bank?s $127 billion in capital. It is in no way life threatening, nor requiring any bailouts. These shares at this price are showing an eye popping low multiple of 7X earnings, and have already been punished enough. Getting shares this cheap in this company is a once in a lifetime gift, and twice in a lifetime if you count the 2009 crash low.

You don?t have to run out and bet the farm right here. Scale in instead, and if the market drops, you can always cost average down. If Greece forces us into major meltdown mode, we can also hedge this? ?RISK ON? trade through taking more aggressive ?RISK OFF? positions, like selling short the (FXE), (SPX), (IWM), (GLD), or the (SLV) by buying puts.

 

 

Short Red and Long Black Was Not Good