Featured Trades: (THE SWORD HANGING OVER THE HOUSING MARKET)

 

3) The Sword Hanging Over the Housing Market. Some 97% of the financing for the housing market is about to disappear. That is how much bankrupt federal agencies Fannie Mae and Freddie Mac are taking down in loan guarantees to the residential housing market.

Created in the wake of the Great Depression (the last one, not this one), these agencies were created to provide subsidies to the homeowners to revive a moribund market. These agencies entered prime time by accepting the securitization of these loans in 1968.They worked in quite obscurity in Washington for decades, quietly fueling successive postwar real estate bubbles. Much of their debt was sold to foreign investors looking to pick up a small premium over Treasuries.

That was until they went one bubble too far, funding the explosion of borrowing that took place during the early part of the 2000's. In 2004, a deregulation move resulting in the dropping of rules against using government guarantees to finance predatory, high cost lending to subprime borrowers.

It was all over but the crying. Once the market broke, default rates skyrocketed, and it suddenly became abundantly clear that these agencies had been grotesquely underpricing risk for decades. Borrowers starting making claims on their guaranties en masse, wiping out their entire capital. In 2008, the two agencies entered a conservatorship administered by the Federal Housing Finance Agency (FHFA), a de facto bankruptcy.

These lenders have been operating in limbo ever since. Like the other sacred cows of entitlements and defense spending, federal home financing is an issue our leaders would rather keep their heads in the sand over. It is clear they need to be recapitalized. But the chance of this congress, fueled by populist, libertarian fantasies, providing another $100 billion in bail out money for a federal agency is zero. That leaves the possibility that they will be eventually be phased out, leaving the private sector to take up the slack.

What will a fully privatized home loan market look like? Try a lot more expensive. That is where you find the jumbo market, which is already fully privatized, as there was never a government mandate to finance the homes of millionaires.

If you have a FICO score over 750, move all of your assets to you lender, including your IRA, 401k, 529 plan, and all of your securities business, you might get a jumbo loan for a 100 basis point premium over a convention FHA loan under $729,750. If you don't jump through all these hoops and refuse to offer your first born child up as collateral, expect to pay a premium of up to 250 basis points, or 7.5% at today's rates. This is why abandoned McMansions have soared across the land like a great blight, and can be rented for 30% of the cash flow demanded by an outright purchase.

What does this mean for residential real estate prices? I'll attempt some quick, back of the envelop calculations here. Raise the cost of financing by 40%, and you can knock 40% off the value of your property. That is off of today's prices, which are already down 40%-60% from the 2007 peak, depending on your neighborhood.

This will inevitably lead to a secondary banking crisis and another stock market crash. If you are wondering about those Armageddon type forecasts that have the Dow plunging down to 3,000, this is the intellectual foundation behind them. That is when we find out how much freedom really costs.

Rent, don't buy. If the roof leaks, the furnace breaks, and the toilet blocks, you just call the landlord, as I have done with my wonderful new rental here in sunny California.

Damn! Should have Refied When I could

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Could This Be a Shorting Opportunity?

1) My Take on the Euro. Entering 2011 as the currency that everyone loved to hate, the Euro has staged a dramatic comeback, much to the chagrin of hedge fund managers and traders alike. Since January, the troubled currency has rallied ten cents from $1.28 to $1.38. Is this the beginning of something big? Or has it shot its wad and headed for a spill?

I vote for the later. The euro is essentially winning the best deck chair on the Titanic contest, the fastest horse at the glue factory, and the prettiest girl at the ugly ball. It's really all about interest rate differentials. At the end of last year, the US economy was growing gangbusters, while Europe was in intensive care. That sent medium and long term American interest rates skyward, while those in Europe languished.

Now the tables have turned. High oil prices are starting to act as a drag on the US, causing economists to rapidly pare back forecasts. Treasury bonds have come back from the dead, bringing the yield on the ten year from 4.70% down to 4.4%. In the meantime, European Central Bank officials have been jawboning the Euro up, threatening interest rate hikes to deal with imagined inflation, no matter that such a policy would be insane to pursue. Hence, we are seeing Euro strength and dollar weakness.

There is another wrinkle to the Euro story here. You would think that high oil prices would be Euro negative, as the continent is a massive importer from that troubled part of the world. But what do Arabs do with the dollars they get for this oil? They buy Euros in order to keep their reserves in a diversified spread. That is why the lurch in crude to $112 in Europe was accompanied by the Euro move to $1.38. This is why the traditional flight to safety bid for the dollar failed to show this time, as it has in all previous oil crises. Some of this spill over buying also explains why the Japanese yen has recently been strong, holding on to the ?81 handle, despite its dismal fundamentals.

How does this party end? US stocks rally once again, US bonds tank, and oil takes a rest, falling well back into the nineties. That could then take the Euro back down to the bottom of its ten dent trading range. A put on the Euro has become a de facto call on US stocks. That's when we test the lower end of the European currency's recent trading range.

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This Party Will Not End Well for the Euro

(SPECIAL $100 OIL ISSUE)

Featured Trades: (MY VICTORY LAP ON OIL)

 

2) My Victory Lap on Oil. One of the boldest predictions that I made in my January 6 asset class forecast for 2011 was that oil would soon hit $100/barrel (click here for the link). My precise words were 'Probably $30 of the current $90 price reflects monetary demand, on top of $60 worth of actual demand from consumers. That will help it grind to $100 sometime in early 2010, and we could spike as high as $120.'

OK, I got the 'grind' part wrong. As it turns out, we have rocketed $18 in a week to a high of $103.40. Brent is up $28 this year. When I made this prediction,? I received tanker fulls of abuse, citing the glut of crude in storage at Cushing, Oklahoma, a slow US economic growth rate, a full strategic petroleum reserve, rapidly progressing conservation measures, and the threat posed by a newly discovered domestic 100 year supply of natural gas. In any case, alternative green energy sources will soon be replacing oil.

Well, there is only two days' worth of supply at Cushing, and they're full because the Canadian tar sands companies have been bringing new supplies on stream. The economy grew at a 4% rate, rather than the 2% many thought. Natural gas is nice, but it will take ten years of infrastructure building and deregulation before it starts to compete with oil. I can assure you that not a drop of SPR is coming on to the market. And alternatives are not going to be making a dent in our energy mix any time soon.

What is my just reward for this call? With gasoline well on its way to $5/gallon, my all-electric Nissan Leaf is looking pretty good, even if delivery has now been pushed back to May.

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Featured Trades: (HOW FAR WILL THE MARKETS FALL?), (VIX), (SPX), (SPY)

 

2) How Far Will the Market Fall? Now that we are solidly in 'RISK OFF' mode, traders, managers, and investors are asking how much downside we are looking at. It is safe to say that those who were piling on longs with reckless abandon are now potentially staring into the depths of a great chasm. I have included charts below showing the important Fibonacci support levels. Let's take a look at how far down is down.

*1,300 '? The first big figure. Already broken intraday, but it held the first time.

*1,286 '? The 50 day moving average, the no brainer, most bullish target. The 'buy the dip' crowd takes a first bite here.

*1,280 '? 38.2% Fibonacci support level.

*1,260 '? 50% Fibonacci support level.

*1,230 '? Broken resistance from the November high. Europe blows up again. Take your pick: Spain, Ireland, Britain, Portugal'?

*1,167 '? The 200 day moving average. It must hold for the bull market to stay intact. This is where $5/gallon takes us. Double dip recession talk reemerges. The 'buy the dip' crowd takes a second bite.

*1,117 '? The November low. The 'buy the dip' crowd throws up on its shoes and pukes out the last two 'buys'. We spike down, triggering another 'flash crash.'

*1,000 '? The next really big figure. Ben Bernanke, with the greatest reluctance, announces QE3. Bond prices soar, taking ten year yields to 2%. Homes prices collapse again, triggering a secondary banking crisis.

*666 '? The Saudi regime falls, and 12 million barrels a day disappears from the market for the indefinite future. Unemployment hits 15%. Obama is toast. Your broker turns bearish and tells you to sell everything. Welcome to the Great Depression II. It starts raining frogs.

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But Will He Bounce?

Featured Trades: (BUY THE DIP IN THE AGS), (DBA), (CORN), (MOS), (POT), (AGU), (ANDE), (CPO)

 

3) A Buying Opportunity is Setting Up for the Ags. In January, I wimped out of my hefty long position in the grain ETF (JJG), hoping to sidestep a potential sell off going into a dreaded US Department of Agriculture crop report, which last year triggered limit down moves. The report turned out to be benign, and I ended up sidestepping an 18% pop in the security.

It is now six weeks later, and we have our limit down moves across the entire ag space. But this time it is a global '?RISK OFF' trade triggered by the calamitous events in Libya. I just received word that a close friend working there for an oil major was safely airlifted to Malta, while another reader emails me that Khadafi is dynamiting pipelines to prevent them falling into the hands of rebels. A declaration of 'force majeure' does little to calm investors. Given that the ags have been among the best performers this year, it only makes sense that a flight to safety delivers to them the worst drubbing.

If you are still holding your position in this space, don't sweat too many bullets. This is but a kink in an upward trajectory that has possibly another two years to run. The world is still making people faster than the food to feed them. Almost every major supplier around the world is facing disruption. Supplies are at multi decade lows. A hungrier, more calorie addicted middle class is still burgeoning in emerging markets. Did I mention the threat to the food supply by global warming and melting glaciers? Food driven inflation isn't going away anytime soon.

If you have any doubts, take a look at the chart below of the percentage of annual income spent on food by country. It starts with a low of 7% for Americans, and goes hyperbolic to 75% for several African countries. When you already spend 75% of your income on food, the only way to cope with a further 50% price increase is to eat less. Not easy when you are surviving on 1,000 calories a day. Expect higher prices, political instability, hoarding, and mass suffering to result.

I have been a huge bull on the ag space since I put out my watershed piece last June, a call that turned out to be immensely profitable for everyone who participated (click here for 'Going Back Into the Ags'). Use the current distress to add to your ag positions, or pick them up if you have not already done so. Look at my favorites in the space the ag ETF (DBA), the corn ETF (CORN), and equities Mosaic (MOS), Potash (POT), and Agrium (AGU). When I see a short term bottom, I'll try to shoot out a trade alert, if I am clever enough to spot it.

You might also add a couple of new names, like Andersons, Inc.? (ANDE), which is involved in crop storage and fertilizer. Also visit and Corn Products International (CPO), which is benefiting from consumer flight from record high sugar prices towards cheaper high fructose corn syrup.

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Here's Where I Want to Buy the Dip