March 3, 2008

Market Comments for March 3, 2008

1) Natural Gas soared again to a new two year high of $9.61 in its race to catch up with crude. Gold flew to $991, just short of my short term target of $1,000. More concerns about power outages in South Africa.

2) The Sage of Omaha, Warren Buffet, released his annual letter to investors, a must read for all students of the market. A $10,000 investment in his Berkshire Hathaway shares in 1965 would be worth $31 million today. I have been following him for 20 years and have always admired his discipline and his wit.

3) The next shoe to fall in the financial crisis will be the bankruptcy of several large fixed income oriented hedge funds. These funds have earned outsized returns of 30%-40% per annum shorting Treasuries and buying every piece of high yield junk out there on a highly leveraged basis, from credit default swaps to collateralized debt obligations to Icelandic long term bonds. Now Treasuries are gong up and there are no bids for these long positions. Vulture investors like Buffet are being shown $5 billion portfolios of these distressed securities on a daily basis.

4) Many hedge funds invest purely on mindless statistical reversions to a mean strategy. When prices are two standard deviations above a mean, they sell, and when prices are two standard deviations below a mean, they buy. Not too much thought there! The problem is that we are now at 6 standard deviations for almost all fixed income securities which equates to a once in 2,000 years event. The aggregate size of the long positions run by these strategies is in the trillions of dollars. There are now cascading margin calls flooding throughout the industry. That is why these funds always eventually go bust. It seems these days that the 100 year floods are happening every two years. It is a basic flaw in the Black-Schoales equation. Models are great as long as you know when to toss them out. These are just tools, not the Gospel Truth.

5) The big hit today was in securities backed by commercial mortgages. Watch out. Terms are tightening by leaps and bounds.

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