Market Comments for June 5, 2008

1) Natural gas has hit a new three year high every day this week, reaching $12.55. Demand destruction that is hurting crude doesn't apply to natural gas because cars or airplanes don't use it. A mid West heat wave is boosting air conditioner demand, and we are only five days into the hurricane season.

2) Leading the charge shorting Lehman stock has been David Einhorn of Greenlight Capital, who has just published a book panning the injured investment bank entitled Fooling Some of the People All of the Time. For an encyclopedic listing of Lehman's flaws go to www.greenlightcapital.com. His basic message is that Lehman has lied to cover up huge sub prime losses in order to protect upper management, thus overvaluing the stock. Lehman is alone among major banks in failing to disclose major losses and avoiding foreign capital fund raising efforts. Lehman was a major player in the sub prime arena and this business is never coming back. The bank has so far sold $100 billion in assets to reduce leverage.

3) United Airlines (UAUA) is grounding their 100 most fuel consuming planes, about one fifth of their fleet. They are laying off 1,600 staff, and canceling their least profitable flights. Airline stocks have rocketed for a second day powered by falling crude. Please recall my recommendation to buy airlines on May 27. United Airlines (UAUA) has risen 40% since then and American Airlines (AAR) is up 31%. These both represent cheap undated puts on crude.

4) The coal group, which is up 100% in a year, has so far been immune to the energy sell off. Large, out of the money call buying persists. Peabody (BTU) is my favorite, followed by Alpha (ANR), Massey (MEE), Consol, and International Coal (ICO). When crude turns, you can kiss this sector goodbye.

5) The dollar broke through to a new $1.53 handle against the euro, then gapped back to $1.55 when the ECB's Trichet said he may have to resort to interest rate raises to cope with high commodity prices.

6) The Mortgage Bankers Association released Q1 default data. 6.35% of all US home loans are delinquent, 2.47% are in foreclosure, and 0.99% just recently entered foreclosure.

THOUGHT OF THE DAY

It is remarkable how well the Dow stocks of ?08 are doing. I'm talking about 1908, not 2008. US Steel (X), the railroads, coal, oil, shipping, agricultural, and mining shares have had a fabulous year. It all looks like the personal portfolio of the original JP Morgan. The only stocks from that era that have disappointed are the banks.

Market Comments for June 4, 2008

1) Weekly Crude supplies increased and both India and Malaysia announced they are cutting gasoline subsidies, indicating that global demand destruction is accelerating. Crude fell from $125 to $121.80. Traders are now selling every rally. If this picks up momentum, we could see $100 in a few weeks. Airlines rocketed today, going up 5%-10% across the board.

2) General Motors announced that sales for May were down a staggering 30%. The company is closing four truck plants and laying off 10,000 people for a cost savings of $1 billion. It is also putting its Hummer division up for sale. The trouble is that no one wants to buy a single Hummer, let alone the entire division. The launch of the Chevy Volt has been pushed back to 2010. The stock has hit a 26 year low. GM's US market share fell below 20% for the first time in May. GM stock is acting like it is going to zero. I remember when this was America's preeminent company. Oh, how the mighty have fallen!

3) In May the number one selling car in the US was the Honda Civic, the first time since 1991. The car gets 35 miles/gallon, costs $20,000 new and comes with a 100,000 mile warranty. The hybrid costs $26,000.

4) Lehman has become the lead stock in the market. They said that they have no need to raise capital. The trouble is that no one believes them. The stock has plummeted from $50 to $29 in 5 weeks. Today the Lehman July $2.50 puts traded in huge size. Then Merrill Lynch put out a 'buy' recommendation and we got a rally back to $32. The company put on hedges against many of their lower rated debt positions at the bottom of the market in March. Since then the debt markets have improved, so now the hedges are costing them a fortune. The company is due to report its first loss in a few weeks since the company went public in 1992.

5) Talk about unintended consequences of high gasoline prices. Profits are surging at insurance companies because less driving, and slower fuel saving driving, means fewer car accidents. Buy Geico and Allstate. AAA members are deliberately running out of gas so they can get a free gallon that members in distress deserve.

6) The ultimate solution to the food crisis will be greater productivity through genetic engineering. In 1960 US farmers produced 16 bushels of corn per acre. They currently produce 156 bushels per acre. If only we could get the Europeans, who have a phobia about genetic engineering and call it ?frankenfood?, to eat the stuff!

Market Comments for June 3, 2008

1) There was massive liquidation of hedge fund longs in crude, with outstanding positions being reduced by 80%, according to CFTC statistics. Crude plunged today from $129 to $124.50. The crude July 150 calls you could have shorted yesterday at $280 could be bought back today for $70. The one day profit on this would have been $283,000. The combined profit on the two crude options trades I recommended so far would have been $773,000, or 25.8% of your $3 million capital. These kinds of profits can only be made in rare markets with extreme volatility and enormous divergences from traditional benchmarks, like we have now.

2) Lehman stock fell another 10% today as it led the charge to the downside for the financials. Bond insurance rates are now indicating a 60% chance of a default on Lehman debt. However, junk bond spreads, LIBOR spreads, credit default spreads for other companies, and volatility indexes, are indicating that the current financial meltdown won't be as severe as the one in March.

3) The US is facing an engineer crisis. Last year China graduated 644,000 engineers, India 350,000, and the US only 70,000. Although half of the Chinese and Indian engineers are only educated to the level of a US trade or technical college, half of all US engineering graduates are foreign born. The reasons given are the starvation of funds for the K-12 public education system over the last 30 years, bleeding off of the best students into higher paying professions in investment banking and law, and the fact that engineering is not 'cool' outside of the gaming community.

4) The publicly traded stock exchanges such as CME Group (CME) and NYSE-Euronext (NYX) have been beaten with the ugly stick this year. The stocks are off up to 45%. There are fears that government regulation will force them to turn off the printing presses. Since these are the guys who sell shovels to the gold miners, they bear watching on any upturn in trading volumes. Of the two, NYX is the better play.

5) In the last week, I have seen a number of bizarre reports of theft as the commodity boom wreaks its unintended consequences on the economy. Gone missing are used restaurant grease (for biodiesel), fertilizer, guano, manhole covers, copper rain gutters from luxury homes, crude oil taken directly from wells, and of course lots of gasoline. Local police departments are unequipped to deal with this crime wave. Can we expect a 'French Fry Grease Special Victims Unit'?

6) At the G-7 meeting in Barcelona, Fed chairman Ben Bernanke provided some verbal support for the dollar which jumped to $1.54/euro.

7) Emerging markets have had nothing less than a spectacular run. A booming global economy and torrid commodity prices have enabled them to run up huge current account surpluses and reserve for the first time in their histories. Many are now net creditors to the US. Talk about trading places! But things have run too far too fast and the charts are close to a double top. Go short the iShares MSCI Emerging Market ETF (EEM) at $50. If things go bad, emerging markets will drop twice as fast as developed markets. Don?t believe the decoupling theory for a nanosecond. Diversification often just means losing more money in more places, only with more exotic sounding names. You could also use a short emerging markets position to hedge a long US equity position.

Market Comments for May 30, 2008

1) Crude stayed in a range of only $3 today, from $126-$129, so more people are talking about a top. Bonds were licking their wounds.

2) Another new word for the lexicon: 'cocooning'. Because of high gas and food prices nobody has enough money to leave the house, so they are staying home, telecommuting whenever they can, and buying whatever they need on the Internet. Buy Amazon, Visa, Master Card, FedEx, and UPS. Go short theme parks, high end restaurant chains, hotel chains, and any company that relies on brick and mortar stores.

3) Best of Breed in the airline industry today is Southwest Airlines (LUV). The company hedged most of its fuel needs through 2012, when crude was at $51/barrel. Not only can the company still make a profit selling tickets for only $100, they can substantially expand their network while others are shrinking.

4) Dell earnings came in much better than expected and the stock jumped 8%. The Michael Dell turnaround is finally happening. The company is moving more aggressively into the consumer space inhabited by Apple and to the international area where, of course, everyone makes money.

5) The average discount on foreclosed homes nationwide is 23%. The best deals were to be had in Indiana where homes sold at a 42% discount to market value.
6) Had a sip of China Silk lately? China has become the 5^th largest wine producer in the world, its chief growing area being on the same latitude as Napa Valley. Most of this is low quality bulk wine. China has the world's fastest growing per capita wine consumption. My recollection is that this stuff is real rotgut, best used for salad dressing.

7) Starbucks has hedged 100% of its coffee needs in the futures markets for this year, about $320 million worth. Coffee has gone up 10% so far this year.

TRADE OF THE DAY

If you had sold the crude July $150 calls last week at $550 you would have covered them this morning at $110 for an eight day profit of $490,000. The hurricane season starts on Sunday and we are one storm away from a possible crude spike to $150 and a natural gas spike to $15. Hanging on to the last $110 in this trade would be imprudent from a risk/reward point of view. Remember, in this business, pigs get slaughtered. Time to say ?Thank you very much Mr. Market,? and move on to the next trade.

Market Comments for May 29, 2008

1) It was a day for the history books in crude. The day started out at $128. Weekly inventories had been anticipated to show an increase of 700,000 barrels, but instead, showed a decline of 8.8 million barrels, the biggest fall in 4 years! Crude lept to $133. Then the CFTC announced it had launched an investigation of oil price manipulation and crude fell $7 to $126. The July $150 calls I strongly recommended selling last week at $550 fell to $110. The hypothetical one week profit on this one trade would have been $490,000.

2) The collapse of the bond market this week has pushed the ten year Treasury note out of its one year trading range. Yields shot up from 4.03% to 4.15% overnight. The futures on the 30 year bond have fallen from 120 to 113.5 since March. I strongly recommended selling these then, and if you had done so, the profit would have been 32%. This is triggering a massive asset allocation trade out of bonds and commodities and into stocks and the dollar. The futures markets are now discounting a 60% chance of Fed interest rate increase by October.

3) I met with Richard Fisher last night, president of the Dallas Fed. He and I competed for an assistant secretary of the Treasury position during the Carter administration. He won, but wrote a nice review of my book. He is a well known inflation hawk and told me that interest rates will rise 'sooner than people expect'. The next day bond prices cratered to a nine month low. He also told my son, who is graduating from the University of Santa Clara, that the best thing he could do is to leave the country and backpack around Asia, accumulating experience on which he can build a career.

4) Steve Balmer played golf with Jerry Yang last weekend. Draw your own conclusions.

5) Hedge funds are seeking out regional banks with the highest ratio of construction loans and shorting the stocks as these have the highest default rate in a recession. The biggest targets have been BB&T of South Carolina and Zions Bank Corp. of Salt Lake City, with 21% of their loan portfolios in construction. This is making construction loans harder to obtain.

6) Q1 GDP was revised up from +0.6% to +0.9%. Where is the recession?

7) 90% of the new electric power plants under construction in the US will be fueled by natural gas. This is why I am a long term bull on natural gas.