Diary Archives

July 18, 2011 - Is the Fat Lady About to Sing Again for the Treasury Bond Market?

Featured Trades: (IS THE FAT LADY SINGING AGAIN FOR THE TREASURY MARKET?)

1) Is the Fat Lady About to Sing Again for the Treasury Bond Market? One of my best calls of the year was to pick the bottom of the Treasury bond market in February and pile readers into synthetic long positions by shorting puts in March. That handy little trade brought in a nice 4.51% profit for my model portfolio.

All good things must come to an end. Since my watershed call, the
Treasury bond market has rallied an awesome ten points. The long bond ETF (TLT) has soared from $87 to $98. My logic was that a flight to safety would send Treasury bond prices to the moon, and that we have gotten in spades. While the 'RISK OFF' trade started for the main indexes, gold, silver, and oil on April 29, it really started in February for copper, banks, and technology two and a half months earlier.

With QE2 now over, I think the party is about to end for the bond market. For the last eight months, the Federal Reserve has taken down virtually all of the Treasury's new issues. That amounts to $75 billion a month. That massive quantitate of new bond buying is over.

Private US and foreign central banks are not going to be able to make up the difference, no matter how many of their cars, textiles, electronics, toys, and finger traps that we buy. This big problem is that the bond market these days is very much like a Ponzi scheme. Unless there is a steady inflow of new suckers, the entire plan collapses like a house of cards.

So I am going to use this strength in the bond market to sell short some out of the money calls with September strikes. I'll be picking strike prices that equate to a ten year yield of 2.40%, last year's low in yields and high in prices. That allows room for a huge, multi decade double top in bond prices to unfold over the next three months and still allow me make money on this trade.

If I can see more confirmation of a double top in the bond markets, then I am going to have a reconciliation with an old flame, the (TBT), the 200% short play on the Treasury market. The only way I can lose money on this trade is for yields to blast through to new 30 year lows, driven by a true double dip recession and an utter collapse in the stock market. The volatility index for the stock market (VIX), stuck at a lowly 17% is telling us that is not going to happen, at least within the next two months, anyway.

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July 15, 2011 - There will be no QE3!

Diary

Featured Trades: (THERE WILL BE NO QE3!)

1) There will be no QE3! Twice in the last week, rumors surfaced that Ben Bernanke was considering a third round of quantitative easing, first in the Fed minutes, and then in Wednesday's congressional testimony. The risk markets rallied furiously, and then quickly gave it all back.

If I have been asked one question more than any other this year, it is whether there will be a QE3. My answer remains the same: No, not on your life, not a snowball's chance in hell. My reasons are legion.

For a start, with the economy growing at a feeble, lethargic 2% rate, there is just enough growth to make QE3 unnecessary. All of the liquidity injected into the system by QE 1 & 2 is still there, but has yet to be used. It is the 'pushing on a string' theory with a turbocharger. That is why the Fed's balance sheet remains at a lofty $2.8 trillion. Bernanke has to wait for the existing liquidity to be put to work before he contemplates the creation of any more.

The political environment in Washington does not auger well for an additional measures to stimulate the economy. While Bernanke is thankfully independent of the congress and the president, he is not an idiot. In any case, there are a dozen additional tools the Fed can put to work to help the economy, which we will only hear about after the fact.

There are many more things that the administration can do as well. Witness the International Energy Agency's recent attempt to manipulate the price of oil down with its release of stockpiles. A mere $10 drop in crude is worth an entire tax cut in terms of its impact on the global economy. Expect many more of these to come.

I think at some point in the future we will see the son of quantitative easing. But not until we are plunging into the next recession in 2012 or 2013 at the latest. Then they will call it by another name. So QE3 is well and truly dead. Please stop asking the question.

What's Next Ben?

July 15, 2011 - Quote of the Day

Diary

'The Fed can print money now, but they can't print jobs,' said Keith Wirtz, president of Fifth Third Asset Management.

July 14, 2011 - The Gold Bulls Are Vindicated

Diary

(SPECIAL GOLD ISSUE)

Featured Trades: (GLD), (RGLD), (AEM), (GBG)

1) The Gold Bulls Are Vindicated. For the faithful who have successfully crossed the desert and suffered the slings and arrows of critics and the ridicule of non-believers, gold's move today to an all-time high of $1,586 delivers the greatest of all vindications. All it took was some comments by Ben Bernanke about the remote prospect of a future QE3, and it was off to the races. Another round of the European sovereign debt crisis is sending panicky continentals into gold in droves. Yesterday, buying of gold ETF's like (GLD) reached 21 tonnes in gold equivalent, one of the largest days on record.

It didn't hurt that we are about to enter a period of traditional strength in the gold market, with the Indian wedding season only two months away. Actually, it wasn't much of a desert, maybe more of a Zen rock garden, as the barbarous relic was stuck in a tedious and tiresome $100 range before it resumed its recent ascent. The Chinese buying I predicted put a floor under the price much higher than traders anticipated, frustrating hoards of buyers lower down.

So now the question arises of what to do with your bounteous profits, and how much risk does the yellow metal present here. I get asked this question a dozen times a day, by some who have been long since the current move started more than a decade ago at $260, and others who stood on the sidelines and watched in awe as it went to the moon, kicking themselves all the way. Is it too late to get in?

They call the yellow metal the barbarous relic for a reason. Let's face it. We've had a great run. Gold has been one of the top performing assets by a long shot, soaring some 510% since 2002, while most other asset classes sucked. Investors did even better in the futures, leveraged ETF's like the (UGL), and gold mining shares or their out of the money calls.

Anyone considering a short here will be insane to do so, as you will be going against the long term trend. Obama has not suddenly turned into a paragon of fiscal rectitude, and Ben Bernanke still has the keys to the printing presses. The Fed has yet to even admit its role in the credit bubble of the last decade. Fiat paper currencies are still running a frenzied race to the bottom. Politicians of both parties see the only way to win elections is to inflate, and to debase the greenback.

Almost all short term money market alternatives globally are yielding close to zero, meaning that the opportunity cost of owning the gold is nil. It turns out that they aren't making gold any more. The output of gold has fallen by 12% annually for the past decade, compared to a doubling of production costs to over $500/ounce.

Reserves everywhere are playing out, and top producer Barrick Gold (ABX) isn't opening a new mine at 15,000 feet in the Andes because it likes the fresh air. The upcoming slugfest in Congress over the debt ceiling will almost certainly cause many investors to just throw up their hands in despair and start shopping for American gold eagles at Amazon.

Now that we have broken out to a new high, many traders think the yellow metal won't pause to catch its breath until we hit $1,600. I still think my long term target of $2,300 is a chip shot, but it might take three years to get there. There are higher predictions of $5,000, $10,000, and $50,000 based on ratios of gold to broadening definitions of monetary assets (see below).

Below are the downside support points on the charts, with my comments.

$1,521 -50 day moving average, probably holds, but a break signals a more serious pull back
$1,422 '? 200 day moving average held last time, should work again. Unlikely to get there, but the world is a big buyer if it does.
$1,050- The 2010 low, the old multiyear high, and the place where the Reserve Bank of India kicked off the current love fest with its surprise 200 tonne purchase in 2009 months ago. Unlikely to get there, but the world is a big buyer if it does. Bet the ranch here.
$680 '? The 2008 low- In your dreams. We aren't going to get a full blown flight to liquidity we saw in that dreadful year. Relegated to the history books for good.

Use any serious dips to accumulate low cost, growing, gold miners with decent valuations, which are enjoying escalating operating leverage the higher the barbaric relic runs. Some new names you might entertain are Royal Gold (RGLD), Agnico-Eagle Mines (AEM), and Great Basin Gold (GBG).

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July 14, 2011 - China's Insatiable Appetite for Gold

Diary

(SPECIAL GOLD ISSUE)

Featured Trades: (GLD)

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2)China's Insatiable Appetite for Gold. Gold bugs and naysayers alike take note. When the world's second largest and fastest growing economy liberalizes gold ownership by individuals, who happened to be the planet's most fastidious savers at a 17% rate, you better pay attention.

Among other reforms, the Middle Kingdom has repealed the death penalty for the illegal importation of the yellow metal, and is now going to some lengths to encourage individual gold ownership.? The potential demand this will unleash boggles the mind. China historically has been a hard currency culture, and only started using paper banknotes when they were forced upon them as a way to repay debts by foreign colonial powers in the late 19^th century.

But the Chinese desire to own gold and silver never went away. In 2010, China imported 73 metric tonnes of the barbaric relic worth $2.6 billion to bring its official holdings to 1,054 metric tonnes. That leaves it far behind the US, which at 8,133 tonnes is the world's largest gold owner. China's gold holdings amount to only $37 billion, or only 1.5% of its $2.45 trillion foreign exchange reserves.

To get China's gold investment up to American levels on a GDP basis, it needs to buy 25 million ounces worth $31 billion. That amounts to 34% of the 2009 global annual production of $110 billion. Being astute traders, the Mandarins at the People's Bank of China are loathe to chase prices, so don't expect them to make up the gap in one shot. Instead, expect a quiet diversion of new current account surpluses out of the greenback and into gold.

You can also expect other emerging market central banks to make the same move. If non G7 central banks from the current 20% average of reserves to the 35% weighting now owned by the G7, it will require 1.3 billion ounces of new purchases, or 20% of the total world supply. I can hear the 'BUY' tickets being written already.

The Chinese aren't going to provide the next spike in gold prices, but they are building a floor higher than anyone expects. That's why the last sell off took us down only 5% to $1,480 before a rebound.

July 14, 2011 - The Ultra Bull Argument for Gold

Diary

(SPECIAL GOLD ISSUE)

Featured Trades: (GLD)

3) The Ultra Bull Argument for Gold. I am constantly barraged with emails from gold bugs who passionately argue that their beloved metal is trading at a tiny fraction of its true value, and that the barbaric relic is really worth $5,000, $10,000, or even $50,000 an ounce (GLD). They claim the move in the yellow metal we are seeing is only the beginning of a 30 fold rise in prices similar to what we saw from 1972 to 1979, when it leapt from $32 to $950.

So when the chart below popped up in my in-box showing the gold backing of the US monetary base, I felt obligated to pass it on to you to illustrate one of the intellectual arguments these people are using. To match the 1936 peak, when the monetary base was collapsing, and the double top in 1979 when gold futures first tickled $950, this precious metal has to increase in value by eight times, or to $9,600 an ounce.

I am long term bullish on gold, other precious metals, and virtually all commodities for that matter. But I am not that bullish. It makes my own three year $2,300 prediction positively wimp-like by comparison. The seven year spike up in prices we saw in the seventies, which found me in a very long line in Johannesburg to unload my own krugerands in 1979, was triggered by a number of one off events that will never be repeated.

Some 40 years of demand was unleashed when Richard Nixon took the US off the gold standard and decriminalized private ownership in 1972. Inflation then peaked around 20%. Newly enriched sellers of oil had a strong historical affinity with gold. South Africa, the world's largest gold producer, was then a boycotted international pariah and teetering on the edge of disaster. We are nowhere near the same geopolitical neighborhood today, and hence my more subdued forecast. But then again, I could be wrong.

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July 13, 2011 - Markets Get a Stiff Dose of Reality

Diary

Featured Trades: (MARKETS GET A STIFF DOSE OF REALITY),
(GLD), (SLV), (TLT), (SPX)

1) Markets Get a Stiff Dose of Reality. The global 'RISK ON' TRADE was administered with a stiff dose of smelling salts on Friday with the horrific nonfarm payroll report. The stock market was really leading with its chin. It expected 150,000-200,000 in job gains but got only a pitiful 18,000. The ensuing melt down was global in scale.

The moves recently have been nothing less than stunning. In the last two weeks, the S&P 500 has rallied 100 points and then given up 65. Technical levels have been rendered meaningless, falling like a hot knife through butter. Surveying the carnage from the comfort of a 99% cash position, it's like watching the games in the coliseum where all of the gladiators are getting the thumbs down. Only those in the stands will be left standing.

The data are entirely consistent with the 2%-2.5% GDP growth forecast that I have been pounding the table about since the beginning of the year. On by one, others have come into my fold, continuously ratcheting down their own ebullient predictions, from Goldman Sachs to the Federal Reserve. As a result, traders are getting chopped to death, their momentum driven models forcing them to buy every rally and sell every dip.

I still think too many analysts, economists, and fund managers are working off of old models, expecting unemployment to fall back to 5%, as it has done in past recoveries. I think we will be lucky to see the 7% handle, if that. Structural unemployment is here to stay, no matter how much money the government throws at it. What people seem to be missing is that corporate profits were so good in Q1, and will be nearly as good in Q2, because they aren't hiring anyone.

My only position, short calls on the (TLT) is still looking good. While the ten year Treasury bond has risen four points against me in the latest shakeout, time decay means my position has dropped by a welcome 57%. I'll be looking to increase this short at the next peak in bond prices.

Only gold (GLD) seems to be doing well here, the barbarous relic probing the top end of its six month range. Europeans spooked by the new crisis in Italy and the potential demise of the European currency system are pouring into the safe haven of the yellow metal. Silver (SLV) in the meantime, has taken a nosedive.

All I can say is if Paul Tudor Jones, Louis Bacon, and John Paulson can't make money in this market, I bet you can't either. Better to watch in awe from the sidelines and until the dust settles and let others do the bleeding.

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Did You Say Buy, or Sell?

July 13, 2011 - China's Great Grain Robbery

Diary

Featured Trades: (CHINA'S GREAT GRAIN ROBBERY), (CORN), (JJG)

2) China's Great Grain Robbery. The Chinese are nothing if not opportunistic. You may recall that a shocking increase in this year's corn crop predicted by the US Department of Agriculture triggered a series of limit down moves in the grain markets only 12 days ago (click here for 'The Great Grain Massacre'). The corn ETF (CORN) was down by a gut churning 13.2% by the time the crying was over, while the grain ETF (JJG) was off by 9.8%. Despite terrible weather and soil conditions, farmers planted anyway, leading to a 1.52 million bushel increase in the forecast crop.

Last week, The Chinese came in and bought over 500,000 bushels, some one third of the surprise excess, and more than they buy in a normal year. Indications are that the buying may continue, with senior Chinese government officials openly doubting the veracity of the USDA figures.

All I can say is 'Great Trade'. The Middle Kingdom is no doubt driven by serious draughts in the western part of the country which has forced them to become a major importer for the first time in years.

I believe that there is something much bigger going on here. I refer you to the piece I sent you last week, 'The Bull Market in Food is Only Just Starting' (click here). The improving Chinese diet is starting to take a big bite out of the global grain market, with the total number of calories per person nearly doubling over the past two decades. Expect this to continue for the rest of your investment lifetime. The moral here is to use any serious dips in the ag space to pick up exposure to this sector.

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Look Who's Eating Your Lunch

July 12, 2011 - The Cooling Market for Hedge Fund Traders

Diary

Featured Trades: (THE COOLING MARKET FOR HEDGE FUND TRADERS)

1) The Cooling Market for Hedge Fund Traders. The tide is suddenly heading out to sea for aspiring hedge fund traders. Ilana Weinstein of the IDW Group, which specializes in hedge fund recruitment, says that the new financial regulation bill has fundamentally changed the supply and demand balance for hedge fund managers.

Star traders at major investment banks with great track records used to be able to pick and choose among the large funds bidding for their services. Now there is a torrent of talent pouring into the marketplace fleeing the onerous restrictions of the Dodd-Frank, pay caps, greater disclosure, and more scrutiny from the SEC. Low trading volumes have caused the banks to scale back from a first half hiring binge.

Hedge funds, whose own recruiting is driven more by capital flows, have also crimped new hiring, their own modest first half returns keeping new investors at bay. With short interest rates near zero, and the yield curve flattening beyond all recognition, the double digit returns of yesteryear are but distant memories. Instead, many hot shots are heading out on their own, setting up new boutique firms with substantially smaller amounts of capital.

Could we be setting up for a bonus draught like the one we saw in 2008?

Hedge12

July 12, 2011 - The Skinny on Lithium

Diary

Featured Trades: (THE SKINNY ON LITHIUM)

2) The Skinny on Lithium. Long time readers of this letter know that I have been a bull on lithium plays, my pick in the sector, Chile's Sociedad Quimica Y Minera (SQM), bringing in a handy 440% pop off the lows in 2009. You couldn't lose, because if the car battery boom faded, they always had a great fertilizer business to fall back on.

Since I'm in a report reading mood, I thought I would sit back in my Aeron office chair, put my feet up on my polished beech desk, and plow through the numerous submissions forwarded to me by readers who attended the first 'Lithium Supply and Markets Conference' in Santiago, Chile.

The bad news is that a truly economic, price competitive lithium battery is still some ways off. Prices for lithium-ion batteries for hybrid electric vehicles (HEV) need to drop by 50% and those for plug-in hybrid electric vehicles (PHEV) by 67%-80% in order to compete on a level playing field with carbon based fuels.

Gasoline has 64 times more energy per unit of weight than lithium batteries, but this advantage is partially offset by electric motors that are four times more efficient than conventional piston engines. Lighter weight cars and other design improvements, like recapturing power when braking, shrink the lead further.

Dr. Steven Chu's Department of Energy is pouring money into research on an amazingly wide front, and strides are being made with different electrodes (silver, sulfur, manganese), leading to rapid advances in inorganic chemistry. The challenges are formidable, with overcharged large lithium ion batteries prone to explode or catch on fire, or internally or externally short circuit.

The conservative big car companies, Toyota and Honda, have stuck with proven nickel metal hydride batteries offering half the power per weight, and are understandably reluctant to make the needed multibillion dollar investments until more is known about the long term life of lithium batteries.

Another wrinkle is that Bolivia, the Saudi Arabia of lithium salt reserves, has effectively nationalized the industry before it got off the ground, limiting its investment in development to $350 million. As the production of EV's, HEV's, and PHEV's is expected to ramp up to 5 million vehicles a year by 2020, this could be a problem.

Many in the industry expect that lithium prices will not be driven by demand from car makers, but by the price of oil. Take crude up to $150 again, and all of a sudden, everything works.

The intelligent way to approach the industry now is to invest in low cost producers of proven battery technology, like Enersys (ENS), Exide Technologies (XIDE), C&D Technologies (CHP), and ZBB Energy (ZBB). Leave the pie in the sky stuff for later.

Unlike past battery car movements, this one is not going to end up crushed in a junkyard. I'll let you know how my lithium battery powered all electric (EV) Nissan Leaf works out, which I just took delivery of last week.