(SPECIAL TREASURY BOND ISSUE)
Featured Trades: (THE TREASURY BOND CRASH IN PROGRESS)
1) The Case Against Treasury Bonds. If you want to delve into the case against the future of US Treasury bonds in all its glory, take a look at the November/December issue of Foreign Affairs, the establishment bimonthly journal read by academics, intelligence agencies, and politicians alike, which I am sure you all have sitting on your nightstands. In a well researched and thought out article penned by Roger C. Altman and Richard N. Haass, the road to ruin ahead of us is clearly laid out.
The US has no history of excessive debt, except during WWII, when it briefly exceeded 100% of GDP. That abruptly changed in 2001, when George W. Bush took office, despite his loss of the popular vote. In short order, the new president implemented massive tax cuts, provided expanded Medicare benefits for seniors, and launched two wars, causing budgets deficits to explode at the fastest rate in history. To accomplish this, strict 'pay as you go' rules enforced by the previous Clinton administration were scrapped. The net net was to double the national debt to $10.5 trillion in a mere eight years.
Another $2.5 trillion in Keynesian reflationary deficit spending by president Obama since then has taken matters from bad to worse. The Congressional Budget Office is now forecasting that, with the current spending trajectory and the new tax compromise, total debt will reach $23 trillion by 2020, or some 160% of today's GDP, 1.6 times the WWII peak.
By then, the Treasury will have to pay a staggering $5 trillion a year just to roll over maturing debt. What's more, these figures greatly understate the severity of the problem. They do not include another $9 trillion in debts guaranteed by the federal government, such as bonds issued by home mortgage providers, Fannie Mae and Freddie Mac. State and local governments owe another $3 trillion. Double interest rates, a certainty if the current commodity price inflation continues, and our debt service burden doubles as well.
It is unlikely that the warring parties in Congress will kiss and make up anytime soon. It is therefore likely that the capital markets will emerge as the sole source of any fiscal discipline, with the return of the 'bond vigilantes.' They have already made their predatory presence known in the profligate nations of Europe, and they are expected to arrive here imminently. Such forces have not been at play in Washington since the early 1980's, when bond yields reached 13%, and homeowners paid 18% for mortgages. Since foreign investors hold 50% of our debt, policy responses will not be dictated by the US, but by the Mandarins in Beijing and Tokyo. They could enforce a cut back in defense spending from the current annual $700 billion. They might even demand a retreat from our $150 billion a year commitments in Iraq and Afghanistan.
Personally, I think the US will never recover from the debt explosions engineered by Bush and by 'deficits don't count' vice president Chaney. The outcome has permanently lowered standards of living for middle class Americans and reduced influence on the global stage. But I'm not going to get mad, I'm going to get even. I am going to make a killing profiting from the coming collapse of the US Treasury market through buying the leveraged short Treasury bond ETF, the (TBT). Sure the 40% gain since august has been nice, but it is only the appetizer. My recently joined 'Macro Millionaires' have been able to book a quick 20% profit. The main course has yet to come. I am sticking to my long term forecast for this fund of $200, and that is despite a hefty and rising cost of carry of nearly 1% a month.
Have a nice day.
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Damn, I Should Have Voted for Gore!
(SPECIAL TREASURY BOND ISSUE)
Featured Trades: (TBT), (THE TECHNICAL CASE AGAINST BONDS)
2) The Technical Case for the TBT. Louise Yamada, one of the most widely followed technical analysts in the market, says the 29 year bull market in Treasury bonds is coming to a close.
Looking at the 200 year history of interest rates in the US, such bull markets are historically 22-37 years in length, and this one is definitely looking long in the tooth. Although doubters insist that you'll never get a collapse in bonds in a deflationary environment, Louise says that all bond peaks occur in such conditions. Yields show prolonged, saucer like bottoms, much like we are seeing now.
She also says that retail interest in such paper surges when interest rates are at multi decade lows, as we saw clearly with last year's flow of funds. When foreign buyers lose interest in our debt, the 30 year Treasury bond is the first place their lack of interest will show up. The dirty little secret among central banks these days is that they are all quietly directing new cash flows away from Treasuries into every possible alternative.
The charts for the 30 year are setting up a perfect head and shoulders top, and when the yield breaks through 4.8% to the upside, watch out. The next stop may be 7%. Her advice is that if you are going to stay in the government bond market, shorten your duration as much as possible. If Louise's scenario plays out, we are about to enter the golden age for the short bond ETF's, like the (TBT).
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(SPECIAL TREASURY BOND ISSUE)
Featured Trades: (AFRICA), (GAF), (EZA), (AFK)
3) Feel Like Investing in a State Sponsor of Terrorism? How about a country whose leaders have stolen $400 billion in the last decade and have seen 300 foreign workers kidnapped? Another country lost four wars in the last 40 years. Still interested? How about a country that suffers one of the world's highest AIDs rates, endures regular insurrections where all of the Westerners get massacred, and racked up 5 million dead in a continuous civil war?
Then, Africa is the place for you, the world's largest source of gold, diamonds, chocolate, and cobalt! The countries above are Libya, Nigeria, Egypt, and the Congo. Below the radar of the investment community since the colonial days, the Dark Continent has recently been attracting the attention of large hedge funds and private equity firms.
Goldman Sachs has set up Emerging Capital Partners, which has already invested $2 billion there. China sees the writing on the wall, and has launched a latter day colonization effort, taking a 20% equity stake in South Africa's Standard Bank, the largest on the continent. There are now thought to be over one million Chinese agricultural workers in Africa.
In fact, foreign direct investment last year jumped from $53 billion to $61 billion, while cross border M & A leapt from $10.2 billion to $26.3 billion. The angle here is that all of the terrible headlines above are in the price, that prices are very low, and the perceived risk is much greater than actual risk.
Price earnings multiples are low single digits, cash flows are huge, and returns of capital within two years are not unheard of. These numbers remind me of those found in Japan during the fifties, right after it lost WWII.
The reality is that Africa's 900 million have unlimited demand for almost everything, and there is scant supply, with many firms enjoying local monopolies. The big plays are your classic early emerging market targets, like banking, telecommunications, electric power, and other infrastructure.
For example, in the last decade, the number of telephones has soared from 350,000 to 10 million. It's like the early days of investing in China in the seventies, when the adventurous only played when they could double their money in two years, because the risks were so high.
This is definitely not for day traders. If you are willing to give up a lot of short term liquidity for a high long term return, then look at the Market Vectors Africa Index ETF (AFK), which has rocketed by 89% from the March lows to the recent highs, and has 29% of its holdings in South Africa and 20% in Nigeria. There is also the SPDR S&P Emerging Middle East & Africa ETF (GAF), which reeled in a blistering 103% gain. For more of a rifle shot, entertain the iShares MSCI South Africa Index Fund (EZA). Don't rush out and buy these today. Instead, wait for emerging markets to come back in vogue, I send you are trade alert when this is going to happen.
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Meet Your New Business Partner
Featured Trades: (THE POPULATION BOOM)
1) The Population Boom. On this most important day of the crop report, I thought that I would refer you to one of my favorite unconventional research sources, National Geographic Magazine. In their century long coverage of exotic places, cultures, and practices, they inadvertently shed light on broad global trends that deeply affect the rest of us. Plus, the pictures are great. The January 2011 issue celebrates the approach of the world's population to 7 billion, and the implications therein.
Long time readers of this letter know that demographic issues will be one of the most important drivers of all asset prices for the rest of our lives (click here). The magazine expects that population will reach 9 billion by 2045, the earliest date that I have seen so far. Can the planet take the strain? Early religious leaders often cast Armageddon and Revelations in terms of an exploding population exhausting all resources, leaving the living to envy the dead. They may not be far wrong.
A number of developments have postponed the final day of reckoning, including the development of antibiotics, the green revolution, DDT, and birth control pills. Since 1952, life expectancy in India has expanded from 38 years to 64. In China, it has ratcheted up from 41 years to 73. These miracles of modern science explain how our population has soared from 3 billion in a mere 40 years.
The education of the masses may be our only salvation. Leave a married woman at home, and she has eight kids, as our great grandparents did, half of which lived. Educate her, and she goes out and gets a job to raise her family's standard of living, limiting her child bearing to one or two. This is known as the 'demographic transition.' While it occurred over four generations in the developed world, it is happening today in a single generation in much of Asia and Latin America. As a result, fertility around the world is crashing. The US is hovering at just below the replacement rate of 2.1 children per family, thanks to immigration. But China has plummeted to 1.5, Europe is at 1.4, and South Korea has plunged as low as 1.15.
Population pressures are expected to lead to increasing civil strife and resource wars. Some attribute the genocide in Rwanda in 1999, which killed 800,000, as the bloody result of overpopulation. If you want to get a first class foundation in the demographic issue along with a lot of cool graphics and charts, read the story in full by clicking here. I'll be the one to tell you which stocks to buy to capitalize on these trends.
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Featured Trades: (ALASKA OIL SPILL), (DIG)
3) Storm Clouds are Gathering for Oil. Spill six barrels of oil in a remote basement in Northern Alaska, and all of a sudden, 15% of the US oil supply is cut off. That was the response of officials at the Trans Alaska Pipeline over the weekend, no doubt hyper sensitized to accidents in the wake of last year's Gulf oil disaster. BP happens to be the largest shareholder in the line. Does anyone see a coincidence?
The 640,000 barrels a day we get from the home of Sarah Palin, dog sleds, and moose sausage is expected to start flowing again soon. But the event does underscore the fragility of our energy supplies. This is why I think we are going to $110 to $120 sometime this year, and $300 within this decade. The $5 a gallon gasoline this assures explains why I will soon take delivery of a black, all electric Nissan Leaf with a solar roof panel. It is also why my newly enriched Macro Millionaires own the 200% leveraged oil major basket ETF, (DIG), in their trading book, which hit a new all time high today. If you need further convincing about the short, medium, and long term case for oil, take a look at the chart below.
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'All of the irrational behavior has been squeezed out of the auto industry. Now, it's all about profitability,' said Mike Jackson, CEO of Autonation, the largest US car retailer.
Featured Trades: (LAS VEGAS STRATEGY LUNCH REVIEW)
1) Las Vegas Strategy Luncheon Review. It has been a full life. What else could I conclude, finding myself in a luxury suite at the Las Vegas Wynn Hotel with two dozen drunken twenty something's playing 'beer pong' at 2:00 am? It is amazing what some people can do with a ping pong ball.
If there was ever a city that needed a jolt of adrenaline for its economy like the annual Consumer Electronics Show, it is Sin City. Some 130,000 free spending techno geeks made sure that the casinos were packed, every top rate restaurant was sold out, and there was an hour wait to buy jet fuel for private aircraft at the airport. I overheard one lovely woman calling friends on the east coast urging them to fly out asap, as there 'were men everywhere!' I was so busy visiting with investors and subscribers that I didn't even have time to take advantage of a free invitation to the adult entertainment convention down the street to meet the porn stars. Now that is busy!
Every time I visit Las Vegas I feel like I'm an extra in the filming of the sequel of The Bachelor. While having breakfast, I couldn't help but notice a young man, nicely dressed in a suit and a tie, passed out in a rubber dingy floating in the middle of the swimming pool. Buddies were calling to him to paddle shoreward, eliciting only dull groans. A friend walked into the ladies room to find one hottie dressed to kill, but passed out on the floor, while a companion snorted cocaine. And why are they burning so much incense in a no smoking hotel?
On every trip here I always make my rounds speaking to blackjack dealers, waiters, cocktail hostesses, real estate agents, pit bosses, showgirls, and masseuses to get a grass roots read on the real economy. You can see from the pain in their eyes that these people have been through a financial meat grinder. I won't call it a 'thousand yard stare', but it is something close. The City Center and the Bellagio completed high rise condo towers, which are now mothballed. The Venetian Hotel is blighted with the skeletal remains of a new tower whose funding was pulled somewhere around the eighth floor. A clueless investor group sunk at least $3 billion into the massive and nearly completed a 3,339 room, 68 story Fontainebleau Resort, which now sits abandoned. Raider Carl Icahn bought the project for pennies at a fire sale, and is currently stripping it of assets. Instead of laying off 25% of his staff, Steve Wynn wisely cut everyone's shift from eight hours down to six to keep them all eating. One heard stories of desperate friends moving out of foreclosed homes at midnight to avoid the judgmental stares and shame from their neighbors.
The strategy lunch was held amidst a fleet of new Lamborghini's at the Dal Toro restaurant, with the meticulous service enjoyed by all. I never cease to be impressed with the sophistication of the readers who attend these functions. Almost all by now have upgraded to the 'Macro Millionaire' service, and as a result were rolling in new trading profits. Most sank their teeth into the (TBT) trade for an appetizer, feasted on Bank of America (BAC) as a main course, and gorged on Cisco System (CSCO) as a desert. There was much discussion on how long the gravy train will last, and the dozen or so factors that could derail it. Linda won the prize for the greatest distance traveled to the event, some 591 miles from Marin County, California. Spend you Zimbabwean dollars well.
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Lunch With the Lamborghini's
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Featured Trades: (CHARLES NENNER ON HEDGE FUND RADIO),
(SPX), (SOX), (QQQQ), (EEM), (CSCO), (BAC), (BIDU), (XOM),
(CU), (OIL), (OXY),
(WHEAT), (CORN), (DBA), (JJG),
(FXE), (FXA), (FXY), (YCS)
My guest on Hedge Fund Radio this week is Charles Nenner of Charles Nenner Research in Amsterdam. Charles hails from Holland, and has a long career that includes stints at medical school, Merrill Lynch, Rabobank, and ten years at Goldman Sachs. He has spent three decades developing his proprietary Cycle Analysis System, which generates calls of tops and bottoms for every major market in the world.
Charles developed a huge following after 2007, when he accurately nailed the top in the Dow at 14,500 and urged his clients to put on short positions when everyone else was predicting that the market would keep grinding higher. I have been following Charles' daily research reports myself for many years, and found them to be uncannily accurate. Most recently, Charles predicted the last sell off in stocks, missing the exact April 25 top by only one trading day.
Today, Charles Nenner counts major hedge funds, banks, brokerage houses, and high net worth individuals among his clients. You can find out more about Charles' work at his website at www.charlesnenner.com. Today's, Nenner gives us his technical view of the world's major markets. Below, I have broken down Charles' bespoke analysis by asset class.
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Equities
Nenner sees multiple peaks developing in a number of equity indexes coming at the end of January. He is still long the S&P 500, which could run as high as 1,480 in a best case scenario. He will sell his position if the SPX trades below 1248, or by January 25, whatever happens first. Germany and the US will be the equity markets of choice during 2011, while emerging markets are to be avoided. Bank of America (BAC) may have another week to run, maybe ticking at $14.70. Chinese Internet provider Baidu (BIDU) is a buy here at around $100 and may have another 20% left in it. Charles is not a believer in Cisco Systems (CSCO), so I wagered him a case of the fiery Dutch liqueur, Bols, on the outcome.
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Bonds
The wily Dutchman sees an 18 month bear market in bonds that we all should be trading around. Ten year yields will balloon up from the current 3.40% to 4.20% and the 30 year may see as high as 5.30%. Then in 2013, he thinks we will see another dip in the economy, a resurgence of deflation, and a huge rally in bonds that will take ten year yields all the way back down to the 2010 low of 2.0%.
Longer term, he sees rates going up for 30 years, reaching the stratospheric 13% we saw in the early 1980's. A great way to play this will be through the leveraged ETF (TBT). Short term he thinks we could pop back up to $41, where he wants to take a trading profit. After that, you should be buying every dip for the next 20 months.
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Commodities
Nenner's copper target (CU) is $4.82 by the middle of April, up XX% from today's $4.40 . Other commodities have already seen most of their run. Regarding oil, he sees a short term top around $92, and wants to buy it back at the end of January around $85.50. His multiple year view has it going all the way up to $200, hence his pick of ExxonMobile (XOM) as a favorite equity play.? Of the independent oil producers, Charles like Occidental Petroleum (OXY), which he thinks has another 10% left in it.
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Grains
Nenner is hugely bullish on the grains, with wheat as his favorite. He argues that the essential foodstuff could rise as much as 38% to $13. Corn is looking good on the charts. His views reinforce my own theory that the world is making people faster than the food to feed them. Short term, the agricultural ETF (DBA), is peaking, but long term could reach much higher. The grain ETF (JJG) should appreciate until April and could print $56.20, and could keep running all the way into 2013.
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Currencies
There is weak rally in the euro to $1.35, where he wants to sell it for a move to the $1.10's. The Australian dollar (FXA) is reaching a major long term top, and tighter stops are warranted. The Japanese yen (FXY), (YCS) is on the verge of making a major long term high, and Charles is looking for good entry points on the short side. An initial 22% depreciation from ?82 to ?100 is doable in 18 months, and could take the (YCS) up 44% from the present $16 to $23.
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Precious Metals
Gold is also topping around $1,440, as is silver around $31. The barbarous relic looks a lot more interesting around $1,000. He is buying deep out of the money puts on the gold ETF (GLD) for pennies, looking to make a killing on the coming sell off.
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Summary
What would Nenner do with the new money he received today? What are the cleanest trades out there? It's very simple. He would sell the next two point rally in bonds through buying the (TBT). He would buy any dips in the grains, crude and the dollar against the Euro. He would sell any breakdown in the Australian dollar. Finally, he would be laying on big shorts in the Japanese yen right now.
To listen to my interview with Charles Nenner on Hedge Fund Radio in full, please click here.
2011 GLOBAL FORECAST
Featured Trades: (SPX), (QQQQ),(CSCO), (XLF), (BAC), (EEM),(EWZ), (RSX), (PIN), (FXI), (TUR), (EWY), (EWT), (IDX), (GS), (MS),
(TBT), (JNK), (PHB), (HYG), (PCY),
(FXC), (FXA), (YCS), (FXY), (CYB),
(FCX), (VALE), (DIG), (RIG), (JOY), (KOL), (CCJ), (FSLR), (UNG), (JJG), (MOO), (DBA), (MOS), (MON), (AGU), (POT), (CCJ), (NLR), (PHO), (FIW), (CORN),
(GLD), (DGP), (SLV), (PTM), (PALL), (ESS)
The Thumbnail Portfolio
Equities
Bonds
Currencies
Commodities
Precious Metals
Real Estate
1) The Economy. What a difference a quarter makes! It was only last summer that the Golden Gate Bridge Authority closed down its suicide hotline because it kept exceeding its plan minutes. Now, happy days are here again. Of course, you have two guys to thank for this love fest of all asset classes. Ben Bernanke's quantitative easing unleashed $600 billion worth of bond buying on the markets, the net effect will be to add 1% to GDP growth in 2011. Barrack Obama's tax compromise with the Republicans easily adds another 1%. So literally in the span of one week I was forced to ratchet up my own forecast for economic activity from a flaccid 2% to a positively virile 4%.
Cancelled Because of Lack of Interest
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I saw all this setting up last summer, which is why I suddenly flipped to a bullish stance on global equities on September 1 (click here for 'My Equity Scenario for the Rest of 2010' and click here for 'Bring on the Bernanke Put' ). Once the tax deal was made I knew the market would rally for the rest of the year, close on its highs, and continue well into the next. That is exactly what we have gotten so far.
Going forward, we are looking at the best macro trading environment of all time. Here are the reasons why:
1) Government policies have created a Goldilocks scenario on steroids: massive stimulus with zero inflation.
2) Global growth at should reach a heady 5% rate, the best in years.
3) Financial markets have suddenly had to price in an upgrade in US growth from 2% to 4%, and are rushing to catch up with the new reality.
4) Asian economies will see blistering growth rates of 5%-10%.
5) Europe Dead in the water at 1% growth.
6) Liquidity is huge, with $2 trillion is sitting on the sidelines, so there is plenty of dry powder to keep the fireworks going for a while.
Suddenly, Goldilocks is Taking Steroids
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So, party on like there is no tomorrow, and consequence is a corny game show. However, the prudent will be anticipating the inevitable hangover, potentially a horrendous one. This is why the current rally will end, possibly as early has the first quarter.
1) The fundamentals are now so obvious that you can expect everyone to pile in, giving us a year that is front end loaded in every asset class performance. Then you can look for trouble in River City.
2) The market can still spread the joy if the ten year Treasury bond yields up to 4%. Take it to 5%, a real possibility, and it is game over. Move this certainty forward if the blatant runaway inflation in all commodities, food, and energy start to feed into headlines numbers, like the CPI.
3) Crude oil prices of $100 a barrel are now a given. Take them to $120 or more, and look out below.
4) Obama has provided states and municipalities with $400 billion in emergency funding over the last two years. That is now expiring, and with a Republican House of Representatives, there is zero chance this will be renewed, quickly chopping a gut punching 3% off GDP growth.
5) You can count on another European country to blow up. This is what cost us two quarters last year. Personally, I think that in Spain, the rain will fall mainly on the plain.
6) The US government will soon hit its $14.3 trillion debt ceiling. Expect Republicans to refuse to raise it and make maximum hay out of this. This will spook foreign investors in American stocks and bonds and the dollar. After all, if you can't own it, then you have to break it.
7) We have had a one way market for so long that the quant crowd is going to be baying for a reversion to the mean.
8) The QE2 well will start to run dry. Worst case, after watching stock prices go ballistic, Ben Bernanke decides that his reflationary program is working so well that he can afford to end it early, downsizing it to QE 1 ?.
9) This is the most important point of all: All of these are likely to hit the market at the same time, sometime in March or April.
This is why I think 2011 is setting up for a repeat of 2010. Think of it as 'V' shaped 'ground hog year', much like we saw in 2010. A supercharged first quarter is followed by two anesthetic ones. Whether we can find a new set of drivers over the summer will determine if we see a strong fourth quarter and another Santa Claus rally, or lapse back into a double dip and a lost decade. Watch this space.
But How Long Will the Fireworks Last?
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2) Equities (SPX), (QQQQ),(CSCO), (XLF), (BAC), (EEM),(EWZ), (RSX), (PIN), (FXI), (TUR), (EWY), (EWT), (IDX), (GS), (MS). Quantitative easing and our renewed low tax rates seem to be favoring equities more than any other asset class. So on the global stage I want to buy the preeminent lagging market, and that is the US. US corporations are making money hand over fist right now, as incredibly aggressive cost cutting drops straight to the bottom line. Free cash flows are rising at an amazing 20% to 30% a year.
Yet, with earnings for the S&P 500 expected to come in at $95 a share, that puts price earnings multiples at 13.3, towards the low end of its historic 10-20 range. A chip shot takes the (SPX) up 12% to 1,400. If it really get the bit between its teeth, a challenge of the all time high at 1,475 is not impossible before we see a major pull back. That would set up a double top that could define the year, if not the decade.
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Furthermore, I want to buy the principal lagging sector in the lagging market, and that is financials (XLF), (BAC). I expect the brokers to do well in this environment, like Goldman Sachs (GS) and Morgan Stanley (MS), as rising stock prices bring rising trading volumes. This will be the year that Goldman Sachs outperforms gold.
To round out the portfolio, I want to own technology (QQQQ), (CSCO), energy (COP), (XOM), and (OXY), and commodity producing stocks. This is a rising tide that will not lift all boats, so I prefer a few rifle shots in these specific areas.
I expect emerging markets to do well again, but not to deliver the unbelievable triple digit returns we saw in 2010. Think the BRIC's, Brazil (EWZ), Russia (RSX), India (PIN), and China (FXI), with South Korea (EWY), Taiwan (EWT), Turkey (TUR), and Indonesia (IDX) thrown in for a more sophisticated flavor. But as long as China is fighting inflation with interest rate hikes and monetary tightening, performance here is likely to be muted. Keep an itchy trigger finger on your mouse, because when the turn comes, there will be no place to hide. And beat the rush by booking that house in the Hamptons, the lakefront property at Tahoe, or the mega yacht in the Mediterranean, early.
It's Off to the Races for US Equities
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3) Bonds (TBT), (JNK), (PHB), (HYG), (PCY). Shorting the world's most overvalued asset has got to be the big trade for 2011. I'm talking about 30 year US Treasury bonds. The relentless whirring of the printing presses is so loud that they keep me awake at night, even though, according to Mapquest, I live 2,804.08 miles away.
What will be unique with this meltdown is that it will be the first collapse of a bond market in history in a deflationary environment. It is not inflationary fears that will execute the coup de grace for the long bond, it will be the sheer volume of issuance. The Feds have to sell nearly $2.5 trillion of debt to cover a massive budget deficit and to refund maturing paper, easily the largest amount in history.
Pile on top of that billions more in offerings from states and municipalities bleeding white. By end 2010 total government debt will rocket to a staggering 350% of GDP. At some point, the world runs out of buyers. The ten year Treasury bond yield began its inexorable climb last summer from 2.4% to today's 3.4%, and it is clearly on its way to 4.20% or higher.? Even Moody's is talking about a ratings downgrade for the US debt, not that we should give that disgraced institution any credibility whatsoever. It's just a question of how many sticks it takes to break a camel's back.
I am a worshipper of the (TBT), a 200% leveraged bet that long bonds are going down. It has clawed its way back up from $30 to $41, and $52 looks like a chip shot for the first half. Longer term this ETF could hit $200. If interest rates double from the current levels, a virtual certainty, so does America's debt service, from the current 4% to 8% of the budget. If we continue on our current borrowing path, it double's again to 16%, a figure equal to our total defense spending, or some $800 billion a year. That's when the sushi really hits the fan.
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Corporate debt, which see interest rates moved more by credit quality considerations than the yield curve, will continue to trade like high yielding equities, as they did for most of 2010. After last year's cornucopia of bankruptcies seen during the crash, investors are also showing a preference for paying up for securities more senior in the capital structure. That means you're going to have to employ an equity type strategy for this corner of the fixed income market. The global liquidity surge that free money is spawning will boost corporate bonds as much as equities, knocking yields down further.
With the world still in risk accumulation mode, that augers well for the riskiest corner of asset class - junk bonds, whose default rates are not coming in anywhere near where they were predicted just a few months ago. Buy the junk ETF's like (JNK), (PHB), and the (HYG) here for a trade. But don't expect a lot. This could be a year when your principal show zip appreciation and your total income comes entirely from the coupon, which is still running at a loft 7.5% Just don't forget to unload at the first sign of an equity market collapse.
As for municipal bonds, we have only entered round one of a decade of fiscal woes by local government. Still, there is a case for owning munis. No matter what anyone says, taxes are going up, and when they do, this will increase muni values. So if you hate paying taxes, go ahead and buy this exempt paper, but only with the expectation of holding it to maturity. Liquidity could get pretty thin along the way.
Perhaps the best place to live in bond world is in emerging market debt, where you can participate via the (PCY). At least there, you have the tailwinds of strong economies, little outstanding debt, appreciating currencies, and already high interest rates.
4) Currencies (FXC), (FXA), (YCS), (FXY), (CYB). Any trader will tell you to never bet against the trend, and the overwhelming direction for the US dollar for the last 230 years has been down. The only question is how far, how fast. Going short the currency of the world's largest borrower, running the greatest trade and current account deficits in history, with a diminishing long term growth rate is a no brainer.
But once it became every hedge fund trader's free lunch, and positions became so lopsided against the buck, a reversal was inevitable. We seem to be solidly in one of those periodic corrections, which began a months ago, and could continue for several more months, or even years. The euro has its own particular problems, with the cost of a generous social safety net sending EC budget deficits careening. Just look at Greece, with a budget deficit of 12.7% of GDP against the 3% it promised on admission to the once exclusive club. Unwinding of 'hot' longs could easily take us to the $1.20's against the euro, and new momentum driven longs could take us to the $1.10's.
For me, the big currency trade of the year will be to short the Japanese yen. The problems in the Land of the Raising Sun are almost too numerous to count: the world's highest debt to GDP ratio, a horrific demographic problem, and flagging export competitiveness against neighboring China and South Korea, and the world's lowest developed country economic growth rate. Most importantly, Japanese interest rates are likely to remain etched in stone near zero, while rates in the rest of the world rise. That creates a big carry trade that every hedge fund will be gunning for, leading to yen selling and dollar buying in large size.
My play here is a double leveraged short yen ETF, the (YCS), which last traded at $16, and will trade at $24 if the yen drops from ?80 to ?100, as I expect.
For a sleeper, buy the Chinese Yuan ETF (CYB) for your back book, but don't expect more than single digit returns. The middle Kingdom with move Heaven and earth to keep its appreciation modest to maintain their crucial export competitiveness.
Do They Know?
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5) Commodities (FCX), (VALE), (DIG), (RIG), (JOY), (KOL), (CCJ), (FSLR), (UNG), (JJG), (MOO), (DBA), (MOS), (MON), (AGU), (POT), (CCJ), (NLR), (PHO), (FIW), (CORN). This is my favorite asset class for the next decade, as investors increasingly catch on to the secular move out of paper assets into hard ones. Don't buy anything that can be manufactured with a printing press. Focus instead on assets that are in short supply, are enjoying an exponential growth in demand, and take five years to bring new supply online. The Malthusian argument on population growth also applies to commodities; hyperbolic demand inevitably overwhelms linear supply growth.
Of course, we're already eight years into what is probably a 20 year secular bull market for commodities and these things are no longer as cheap as they once were. You'll never buy copper again at 85 cents a pound, versus today's $4.45. Many commodities, like cotton and rare earths saw triple digit returns in 2010, so don't expect a repeat this year. You are going to have to allow these things to breathe. Ultimately this is a demographic play that cashes in on rising standards of living in the biggest and highest growth emerging markets. You can start with the traditional base commodities of copper and iron ore.
The derivative equity plays here are Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE). Add the energies of oil (DIG), coal (KOL), uranium (NLR), and the equities Transocean (RIG), Joy Global (JOY), and Cameco (CCJ). Oil has in fact become the new global de facto currency (along with gold), and 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.
Don't forget alternative energy, which will see stocks dragged up by the impending spike in energy prices. My favorite here is First Solar (FSLR). Skip natural gas (UNG), because the discovery of a new 100 year supply from fracting and horizontal drilling in shale formations is going to overhang this subsector for a long time.
The food commodities are also a great long term Malthusian play, with corn (CORN), wheat, and soybeans (JJG) coming off the back of great returns in 2010. These can be played through the futures or the ETF's (MOO) and (DBA), and the stocks Mosaic (MOS), Monsanto (MON), Potash (POT), and Agrium (AGU). The grain ETF (JJG) is another handy play. Through an unconventional commodity play, the impending shortage of water will make the energy crisis look like a cake walk. You can participate in this most liquid of asset with the ETF's (PHO) and (FIW).
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6) Precious Metals (GLD), (DGP), (SLV), (PTM), (PALL). With gold's whopping great $50, 4% pull back yesterday, I have been deluged by readers asking if this was the peak, if it was the final blow off top, and if gold is finished as an asset class. My answers are no, never, and not on your life. Obama has not suddenly become a paragon of fiscal restraint. Bernanke has not morphed into a tightwad overnight. When I pull a dollar bill out of my wallet, it's as limp as ever.
If you forgot to buy gold at $35, $300, or $800, another entry point is setting up for those who, so far, have missed the gravy train. Let's face it, the precious metals have a severely overbought condition to work off before we make substantial new highs. Remember, the is the asset class that takes the escalator up and the elevator down, and sometimes the window. We could be seeing a replay of 2010, where the yellow metal traded in a sideways range for many months before blasting through to a new all time high and quickly tacking on 25%. Start scaling in around the 200 day moving average at $1,261.
If the institutional world devotes just 5% of their asset to a weighting in the yellow metal, and an emerging market central bank bidding war for gold reserves continues, it has to fly to at least $2,300, the inflation adjusted all time high, or higher. ETF players can look at the 1X (GLD) or the 2X leveraged gold (DGP).
I would also be using the next bout of weakness to pick up the high beta, more volatile precious metal silver (SLV), which I think could hit $50 in the foreseeable future. Silver's 200 day moving average is all the way down at $21, so I doubt it will ever get there. The $50 day moving average at $27 might be a more realistic reentry point. Palladium (PALL) and platinum (PPLT)), which have their own auto related long term fundamentals working in their favor.
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7) Real Estate (ESS). The agony is going to continue in this world of hurt, and any allocation to either residential or commercial real estate is going to be dead money for the next decade. If you strip away the industry fig leaves, and ignore the paid apologists, the excesses in this sector are truly of Biblical proportions. 'Official,' shadow, and bank inventories, and another 1.5 million imminent option arm induced foreclosures, probably mean there is five years worth of supply out there.
Bankrupt Fannie Mae is taking down 75% of the new mortgage in the secondary market, the FHA is taking almost all of the rest, and there is no way the socialization of the mortgage market can continue indefinitely. The jumbo market has ceased to exist except at whopping big premiums, and it is raining McMansions in tony neighborhoods everywhere.
The demographic pressure of 80 million retiring and downsizing baby boomers easily add another five years of supply. The commercial sector is even worse, with valuations off 50%, some 5% of the industry's $1.8 trillion loan book in default, and cap rates soaring from 5% to 8-9%. The refinancing needs of this industry are gargantuan, and except for some triple 'A' paper taken down by the TALF, there is no bid other than from the vultures inhabiting the distressed world.
No one seems to be taking into consideration the fact that huge chunks of the office market are being permanently emptied out by the Internet, which is sending people home to work, transferring their jobs overseas, or vaporizing them altogether. If the liquidity induced surge in stock prices continues, I might even be enticed into shorting some of the big listed REITS, like Essex Properties (EES), which has nearly doubled from its lows, and is choking on its high prices California exposure.
Only buy a home if your wife is nagging you about living in that cardboard box under the freeway overpass. But expect to put up your first born child as collateral, and bring in your entire extended family in as cosigners, if you want to get a bank loan.
Featured Trades: (A PERFECT STORM FOR THE GRAINS)
2) A Perfect Storm is Settling Up for the Grains. I bet I'm the only guy you know whose wedding was filmed by the KGB. In the seventies, my friend, the TASS correspondent, Yuri, shot the entire assembled foreign press at the event at The Foreign Correspondents Club of Japan, undoubtedly for their files in Moscow. What a waste of resources. No wonder they lost the cold war! We've stayed in touch through the years, through the collapse of the Soviet Union and the many wars, revolutions, booms, and busts that followed. He now advises a Russian hedge fund. What else?
When he called me the other day he was in a somewhat agitated state. He said that the damage caused to the Russian wheat crop last year by the draught and fires was so severe that they were unlikely to recover next year. As a result, Russia was likely to swing from a net exporter to a net importer in 2011, possibly requiring as much as 3 million metric tonnes. If his analysis is correct, this would be hugely bullish news not only for wheat, but corn, soybeans, and rice as well.
Russia was once known as the bread basket of Europe, which is why it was invaded by Napoleon in 1812 and the Germans in 1942. They still have a sizeable impact on global prices. In recent years, the country has been a major supplier of the low grade wheat favored by emerging markets, like Egypt and India. Taking them out of the market could trigger the food riots in emerging markets that many analysts have feared.
The Russian news could be the tipping point towards what could become a perfect storm for the grains in 2011. Torrential rains and a typhoon have recently drowned much of the wheat crop in Southeast Australia, and mold and rot have forced farmers to downgrade much of what is left to animal feed. Scorching heat in Argentina, another major exporter, is sending yields plummeting. Even in the US, the lack of a protective snow cover in the Midwest is exposing fields to damaging cold temperatures. This will inevitably lead to downward revisions of output here. On the demand side, the Chinese continue to upgrade both the quantity and quality of caloric content of their diet by the day.
All of this is making my trade alert to buy the grain ETF JJG look like a stroke of genius. While much of this news is already in the price, JJG was on an absolute tear in December, barely pausing to let anybody in. Yet, gain prices are still a shadow of their 2008 highs. To match those highs, wheat needs to rise by 57%, corn 20%, and soybeans 18%. So we could have much further to run. Elevate grain prices to those altitudes, and JJG could rocket by 30% to $67. That is something to sink your teeth into.
The next possible entry point into the grains could come on January 12, when the US Department of Agriculture releases its crop forecast for 2011, one of the most important of the year. Last year's January report painted a surprisingly positive picture, which sent prices plummeting and took months to recover. That report was later shown to be wildly optimistic, as the doubling of prices later proved. Will the government agency similarly err this year? Not if my friend Yuri has anything to say about it.
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