'A lie can travel half way around the world before the truth gets its boots on,' said the 19th century humorist, Mark Twain.
Featured Trades: (CHARLES NENNER)
1) Catching Up With Charles Nenner. I managed to catch up with my friend, technical analyst to the stars, Charles Nenner, and quiz him about his recent relative silence. It has been many months since he predicted that the yen was going to soar from ?95 to ?80, that you should dump your longs before a plunge in the S&P 500 from 1240 to 1,000, or that the Australian dollar would rocket from 78 to 100 cents.
The wily Dutchman explained that he was been sitting on the fence because there is really nothing to do here, echoing sentiments from my own piece on market turning points last week (click here for 'Contemplations in Risk'). His longs in NASDAQ, the ags, and emerging markets were working fine, but he was not inclined to initiate new longs here, and there was no point in stepping in front of the train on the short side.
Charles' daily, weekly, and monthly cycles were drawing sharply diverging conclusions. Take a look at the stock indexes, where the weekly cycles show the Dow and S&P 500 possibly peaking this week, the NASDAQ not until January, and the emerging markets not for the foreseeable future. The best thing is to wait for these conflicts to resolve over time before making any big calls. After all, no one stood over Beethoven and demanded he finish his symphony by Friday.
Charles thinks we are about to enter a period of major dollar strength, but not yet. One area that is starting to look interesting was the volatility index (VIX), which seems to be bottoming out in the high teens, presaging times that the Chinese describe as 'interesting.' One could easily envision a scenario where the dollar is strong, and everything else goes to hell in a hand basket. I plan to get together with Charles in early January to review his 2011 calls across all markets. Premium subscribers can look forward to getting e-mailed a strategic advanced peak.
Featured Trades: (THE TREASURY BOND DILEMMA), (TBT), (IEF)
2) The Treasury Bond Dilemma. There is a very interesting divergence going on in the Treasury bond market which readers should be aware of. The leveraged short ETF for long dated paper, the (TBT), looks like it bottomed in the end of August, indicating that the collapse I have been predicting has already been started, just five days before my seminal post on the topic (click here for 'The Great Bond Market Crash of 2010'). The ETF for seven to ten year paper (IEF), motored on to a new high six weeks later, and has been grinding sideways since, the ten year since levitating at an amazing 2.60% yield.
This is happening because many bond traders believe that Ben Bernanke is going to focus his QEII on durations less than ten years, and will leave long dated paper, like the 30 year, out in the cold. Which is another way of saying that without temporary, artificial government support, all bond markets would be in free fall by now. This gives us all a wonderful insight into how bonds will behave, once QEII is finished, is thought to be halfway done, or gets canceled (click here for 'Ha, Ha, I fooled you' in 'Contemplations on Risk'). I think what these two charts are telling you is that if the great bull market in the (TBT) hasn't started yet, it is not far off.
Featured Trades: (Q3 GDP)
3) There is Less Than Meets the Eye in Q3 GDP. There was much celebration that the US economy managed a 2.0% growth rate in Q3, sending double dippers to the dust bin of history, where they rightfully belong. Of course, you already knew this was going to happen last January, because this is exactly the number I predicted then in my 2010 Asset Allocation Review' (please click here for the call) . I made this prediction because I thought that American companies doing business with the white hot emerging markets would generate just enough growth to offset the huge drag created by moribund industries, like housing, real estate and every shrinking state and local government portions of the economy. This is precisely what unfolded.
A closer examination of the breakdown show that even this modest, lackluster figure may be overstating the true level of business activity. By the time you strip out the 2.2% GDP deflator and the inventory build of 1.4%, real GDP growth was actually negative. The GDP deflator is no doubt being overstated by the huge expansion of the Fed balance sheet. Much of the inventory build was a one time only affair which has since ceased and can't be counted to repeat in the future.
What all this says about the US stock markets is that further rises are going to be driven mostly by a QEII that will lift all boats, especially the yachts. They will be supported less by actually profit making activities of US companies. That is sort of a long winded way of saying that we are in the middle of a mini stock bubble. Party away, but stay close to the exit at all times.
Featured Trades: (RARE EARTHS), (REMX), (MCP), (LYSCF), (AVARF)
2) Is the Rare Earth ETF Calling a Market Top? It looks like the Van Eck mutual fund group reads the Diary of the Mad Hedge Fund Trader, because last week they launched the first ETF (REMX) dedicated to rare earth and strategic metals. The move comes on the heels of incredibly bullish developments in this space over the last six months. These include a ban by China, source of 97% of the world's rare earth supplies, to Japan, a temporary export ban to the US, and a 30% reduction in global export quotas next year.
The new issue immediately gave a boost to the shares of the several names in this sector you have all come to know and love in the pages of this letter, including Molycorp. (MCP), Lynas Corp. (LYNCF), and Avalon Rare Metals (AVARF) (click here for 'Rare Earths Are About to Become a Lot More Rare'). That's becasue the launch of a new ETF in a thinly traded corner of the commodities markets is well known to suck in a ton of new money, as it did with Platinum (PPLT) and Palladium early this year (click here for the call).? MCP alone has moved up a stunning 240% since the end of August, partly on anticipation of the new ETF.
It even includes some outliers in the strategic metal area, like Titanium Metals Corp (TIE), which I mentioned earlier in the year (click here for 'Playing Catch Up With Titanium'). As if the issue needed any help, Secretary of State Hillary Clinton (see above) warned that the world needs to start developing alternative sources for rare earths. I have included the ETF's top ten holdings below.
I have been flooded with emails from readers this week asking if they should pile into the issue. Right here, I wouldn't touch with a ten foot pole. The deal comes on top of underlying equities that have rocketed by 400% and metals prices that have roared tenfold in six months. Great idea, but a little late.
When the CEO of Molycorp says his company's primary product is caught up in a bubble, you have to take notice. I think it's safe to say that if you are not in now, you have missed the move in this cycle. The train has left the station. Better to wait for the inevitable sell off that will come sometime next year, or find a completely different field which offers more immediate upside.
Lynas Corp Ltd (LYSCF.PK)
Iluka Resources Ltd (ILKAF.PK)
Titanium Metals Corp (TIE)
Thompson Creek Metals Co Inc (TC)
OSAKA Titanium Technologies Co
RTI International Metals Inc (RTI)
Toho Titanium Co Ltd
China Molybdenum Co Ltd
Kenmare Resources PLC
Molycorp Inc (MCP)
Featured Trades: (JAPANESE YEN), (FXY), (YCS)
3) Pricking the Bubble in the Yen. Analysts have been puzzled by the relentless appreciation of the Japanese yen, which went out at ?80.40 on Friday, and seems poised to break out to the ?70 handle and an all time high. Having written the authoritative tome on the Japanese banking system 30 years ago (it's in the Library of Congress), I can shed more than a little light on why.
Unknown to most in the trading community, foreign banks have engaged in a massive recapitalization of their Japanese subsidiaries since over the last six months. Since May, excess foreign bank reserves held in yen have soared from $246 billion to $562 billion, an increase of a staggering $316 billion, creating immense upward pressure. Some $136 billion of this poured into the yen in September alone. By comparison, there are only $7.3 billion worth of net longs held in futures markets by speculators.
Ask Japanese senior bankers why this is happening, and you get lame excuses, like anticipation of stiffer capital requirements from the Bank of Japan to head off any future financial crisis. The truth is that banks are using their balance sheets to speculate in the currency markets and boost profits. Adding fuel to the fire has been efforts by the People's Bank of China to diversify out of the dollar as a reserve asset by pouring new cash flows into the yen. This is showing up in a huge jump in overnight bill purchases by foreign investors.
In days of old, countries used to destroy their neighbors by sending in invading armies of screaming warriors swinging great long swords. Today, you simply buy their currency; drive it to ridiculous heights, making its industry hopelessly uncompetitive in the global market place, thus collapsing its economy. This is what China is doing to Japan today.
This explains why the central bank's intervention efforts to slow the yen's appreciation have been an abject failure. In September, total BOJ sales of yen amounted to only $61 billion, and has been spread among a range of lower tier assets, like 'BBB' rated corporate bonds, exchange traded funds (ETF's), and REIT's. The Japanese government is slumming with its own version of QEII. But the amounts so far are miniscule compared to the inflows. They might as well be pissing in the ocean.
There are two ways this kabuki play will go end. The obvious one is for the BOJ to boost its intervention to the $1 trillion that worked the last time it was in this pickle eight years ago. I sense that a Pearl Harbor type surprise attack of this sort is setting up. Suck the shorts in with a series of small, ineffective interventions that invite laughter and derision, and then all of a sudden, its tora, tora, tora and bombs away. The shorts get taken to the cleaners.
The second approach will be more subtle. Banks are currently earning 10 basis points on their excess reserves. Turn this number negative, as Germany and Switzerland did, and the banks will bail on their excess reserves in a heartbeat. It's not a matter of if, but when they do this. Then the 15 year double top chartists have been waiting for will be in place, and one of the great shorts of the decade, and the (FXY) and the (YCS) will be in play. This all may happen very fast, so keep you finger poised over that mouse.
Is the Bank of Japan Planning a Surprise Attack on the Yen Shorts?
Why the Bank of Bank of Japan's Intervention Efforts Aren't Working
Featured Trades: (WORLD SERIES)
1) From Your Mad Hedge Fund Trader Baseball Correspondent. What a game! Burp. The San Francisco Giants trounced the Texas Rangers 11-7 in what had to be one of the most exciting games in World Series History.
I spent the pregame completing my Christmas shopping for the year, feverishly buying commemorative baseballs, knit hats, and T-shirts at $40 a pop. China's trade surplus must be soaring. A Niagara Falls of beer was pouring out of the concession stands. The air was electric with enthusiasm.
Tony Bennett sang the Star Spangled Banner. The F-16's flew in formation 500 feet overhead right on cue. Nancy Pelosi and Mayor Gavin Newsome sat just below me, where else, but in the left infield.? In fact, a foul ball almost landed in the lap of the Speaker of the House of Representatives.
Starting Giants pitcher, Tim Lincecum, seemed to defy the laws of physics, using a slight, boyish frame to throw a sizzling 98 mile per hour fast ball. In the fifth inning the Giants were hitting them like they were playing T-ball, scoring six runs. Both teams looked like they had been cleaned out from a home for juvenile delinquents. Are baseball players getting younger, or am I getting older?
I missed heavyweight, Juan 'The Panda' Uribe, belt out a home run because I was stuck in the 30 minute line to get into the men's room. The red clad Texas Rangers cheering section went comatose, where else, but in the upper right field bleachers.
Tony Bennett then sang I Left My Heart in San Francisco during the seventh inning stretch. Both sides threatened to score in every inning. We spent virtually the entire game standing on our feet screaming our lungs out.
Many thanks to the San Francisco Bay Area readers who emailed encouragements to me throughout the game. To the Texas readers who sent messages like 'Yeeeehaaaaaa Texas' when they scored, a pox on your houses, homesteads, teepees, or wherever you live in that God forsaken land.
When Brian Wilson stuck out the last Ranger hitter, the fireworks went off over the bay. The city exploded into celebration, with cars everywhere honking their horns and cable cars ringing bells. Probably 100,000 poured out of packed bars into the streets for a huge nonstop party. Groping my way through the crowd, I almost got run over by the black GM Suburbans of Nancy Pelosi's Secret Service detail.
I almost fell asleep on the last train home. If I had, I would have ended up at the end of the line at Pittsburgh/Bay Point, where I would have gotten mugged and lost all of my $40 T-shirts. But I didn't. I'm back to Earth today writing this letter with the mother of all hangovers.
Yes, We Have Our Own Team Serial Killer
Featured Trades: (MUNICIPAL BONDS), (NCP), (NVX)
Nuveen California Performance Plus
Nuveen California Dividend Advantage Muni Fund II
2) The Fascinating World of Municipal Bonds. I was fortunate to catch the muni bond wave this year with my recommendations to buy the funds in this sector, the (NCP) and the (NVX) (click here for 'California Municipal Bonds Are a Steal'). I turned negative on bonds of every description in August, fearing that the popping of the government bond bubble could take down the rest of the fixed income universe down with it (click here for 'The Great Bond Market Crash of 2010').
However, there may be some circumstances unique to certain individuals where hanging on to you muni bonds may make some sense. Treasury bond investors are not being compensated for their risk at current yields, but muni bond investors are. Ten year tax free munis are now yielding 2.58%, delivering an effective taxable rate of 3.97% for those in the top end 35% tax bracket.
If the Bush tax cuts are not extended, that yield jacks up to 4.27% for top earners. In the 30 year arena, the effective taxable rate is 6.38%, and a very generous 6.87% without the Bush cuts. That's a lot in this zero yield world we live in. And let's face it, taxes are going up a lot, no matter who wins the election, making these bonds even more valuable.
The risk of an outright default on this paper has been vastly overblown by the media. California's $70 billion in general obligation debt, which is used mostly for infrastructure spending, is at the very top of the seniority structure, followed by $150 billion in retirement benefits debt. These claims are untouchable.
All of the budget cuts going forward will take place with the junior claims in the obligation structure, mostly schools and social services. That is why we are seeing rioting at UC Berkeley and demonstrations at welfare offices. And with the stock market up 78% in 20 months, capital gains will start kicking in, which in peak years account for 40% of total state tax revenues.
For those who would rather leave slugging it out in the markets every day to the younger crowd, who despair at figuring out the 'new normal', or who don't want to deal with the harsh reality that 'buy and hold' is dead, this may be a good option. Sure, you almost certainly will have to take some ugly marks down the road. But if you are willing to hold this paper to maturity, it might be worth it.
Don't Let Them Scare You Away from Muni Bonds
Featured Trades: (CONTEMPLATIONS ON RISK)
1) Contemplations on Risk. The S&P 500 has risen 11 out of the last 13 trading days. Everything in my portfolio is up 50% in the last four months, except for the rare earth stocks which are up 400%. My call that the global equity markets would launch into a surprise up move driven by better than expected earnings, sending shorts scrambling, turned out to be one of the best in my career (click here for 'My Equity Scenario for the Rest of 2010'). So far, 82% of reporting companies have surprised to the upside. It doesn't get any better than this.
Now that everything is ridiculously overbought on a short term basis, I have to ask: What can go wrong with this party? When will investors flip from 'RISK ON' to 'RISK OFF' mode? Should I pick up my ball and go home? I'm sorry, but I am one of those guys who believes that the higher prices go, the more risk they carry, and the more volatility they threaten. Most people believe the opposite.
I see three possible near term inflection points setting up for the markets:
I) The November 2 elections. A surprise Democratic win would send the markets into a tailspin. Much of the buying since august has been driven by an expected Republican takeover of the House of Representatives. If that doesn't materialize as promised, the punch bowl would disappear very quickly.
II) Year End. Many hapless financial advisors have bought the top of the market and then sold the bottom for the second year in a row. As a result, 30% of active managers are now underperforming the index. To catch up, they are buying this year's hottest stocks hand over fist, driving markets higher still. This is why you are seeing so much buying concentrated in lead names like Apple (AAPL), which now accounts for an amazing 20% of the NASDAQ. Flip the page on the calendar and all this buying may end.
III) End Q1, 2011. The QEII surge continues for another five months, the S&P 500 challenges this year's high of 1,240, and New Year cash allocations pour into the market. Then Bernanke says 'Ha Ha, fooled you! I'm not doing any QEII because you guys already did it for me!' We then run into a repeat of 2011 where six months of feast are followed by six months of famine. The 'double dip' scenario once again rears its ugly head. This is what lost decades are supposed to look like.
While I am not certain which of these three scenarios plays out, I know for sure what to do when one hits. 'RISK OFF' means the dollar and volatility go up, and stocks, bonds, commodities, currencies, food, and emerging markets go down. Retail participation in the equity markets shrinks to two guys sitting in rocking chairs on a porch in Arkansas waiting for their cable to get installed.
Don't kid yourself into thinking that you can hedge against these losses, or that diversification will protect you. We live in a binary, bipolar world, and the only hedge that truly works is cash.
Featured Trades: (PEAK TREASURY BONDS), (TBT), (TMV)
ProShares Ultra Short Lehman 20 + Year Treasury ETF
Direxion Daily 20 Year Plus Treasury Bear 3X Shares ETF
2) The Fat Lady is Still Singing in the Treasury Market. To say that things have gone well for the Treasury bond market this year would be one of the understatements of the century. First there was a global flight to safety triggered by the European debt crisis. Then there was the mad rush by hedge funds to cover shorts in securities they believed were the world's most overpriced assets. Then Ben Bernanke appeared on the scene with QEII, sending bond prices everywhere to 50 year highs.
Every academic study showing that government paper had 30 years of underperformance ahead of them, including my own, only seemed to drive prices higher (click here for 'A Visit to the Insane Asylum'). In fact, my report on 'The Great Bond Market Crash of 2010' lagged the actual peak in bond prices by just five days (click here for the piece). At the August high, the Treasury market was effectively discounting 0% inflation for ten years, an insanity I was happy to bet against.
The recent action in the markets suggests that the turn may finally be behind us. Why have bond prices been falling for the past month, despite an assumed promise by the Fed to provide unlimited amounts of liquidity? Why has a ton of Chinese and other foreign buyers failed to set a new high. Is it possible that the fat lady is at last singing in the Treasury bond market?
Let's say we get a 'RISK OFF' reversal in global financial markets. The short Treasury Bond ETF (TBT) bottomed at $30 at the end of August and has made it back up to $34.? Take it back to this year's high of $52 and that gives you a 73% gain off the bottom. The 2009 high gets you to $60, an even 100% return. If you don't feel like betting the ranch here and want to approach this in a sober, risk controlled manner, look at the cheap, out-of-the-money March or June, 2011 $45 calls on the (TBT). Get this one right and the profit will be several fold.
