Newsletter Archives

Texas Tea Takes a Dive

Take a Look at the chart below and you will see that the price of oil is breaking key support. Texas tea has now backed off $13 since the end of August, and lower prices beckon.

It turned out that oil made an initial peak with the Egyptian Army?s ferocious and bloody attack on the Muslim Brotherhood. I hate to sound cynical here, but count the daily bodies in the street, which has been trending down sharply since the 1,000 plus tally. Fewer bodies mean lower oil prices. This broke the back of the fundamentalist opposition movement, which has accounted for the $20 spike in oil prices since June.

We then saw a secondary peak at $112.50 with Secretary of State John Kerry?s harsh reaction to the Syrian gas attack. We were a day away from launching the missiles when the Russians delivered a last ditch compromise peace offering. That firmly put Syria on a back burner for several months at the least. Oil has been falling ever since.

This returns us to the longer-term fundamental trend for oil, which is sideways at best, and down big at worst. The US is flooding the world?s oil markets with energy in all its many forms. The driver here is American fracking technology, which will continue to upend the traditional energy markets for decades to come.

It?s just a matter of time before fracking goes mainstream in Europe, especially in the big coal countries of Germany, Poland, and England. Then they can thumb their noses at Russia, a major gas supplier over the last thirty years. China will follow. You could even frack in the Middle East.

In a crucial news item that wasn?t reported nationally, the California legislature voted down a measure to ban hydraulic fracturing in their state. It was defeated in a democratically controlled body. As the Golden State is the most anti energy state in the country, this gives the state a flashing green light to move forward against environmentalist opposition. There is a ton more of new supply coming. This is what the weakness in the price of natural gas is telling you (UNG).

We also received a new negative for oil this month, the collapse of the emerging market currencies, stock markets, and bonds, especially the Indian rupee. This reduces their international purchasing power in US dollar terms, thus raising the cost of oil in local currency terms. You see, oil is priced in dollars. As the emerging markets have seen the largest growth in demand for oil in recent years, this can only be bad for prices.

In terms of my own trading portfolio, I wanted to have a ?RISK OFF? position, like an oil short, to hedge my existing ?RISK ON? positions. US stock markets could be weak into October, and they will take oil down with them.

The energy inventory figures are another enormous tell, which indicate that the industry is choking on excess supplies. The summer driving season is now a distant memory, and winter has yet to hit. These are grim tidings for oil.

Finally, there is that last resort, the charts. Check out those for the (USO) and oil and it very much looks like we have a classic head and shoulders top in place. That is the straw that breaks the camel?s back.

The only way I am wrong on my oil call is if the Chinese economy is about to take off like a rocket. They are the marginal big swing player in this market. But there is absolutely no sign of that happening in the economic data. If anything, the collapse in emerging markets suggest that conditions in the Middle Kingdom are about to get worse before they get better.

This is not an ideal place to initiate new shorts, unless you are a died-in-the-wool momentum player. But we are only one headline away from more bad news from the Middle East, which would deliver an instant $5 pop in oil prices. That?s what you want to sell into.

I don?t have any brilliant option plays for oil here. So better to play the leveraged short oil ETF?s. Those would include the ProShares Ultra Short DJ-AIG Crude Oil ETF (SCO) and the PowerShares DB Crude Oil Double Short ETN (DTO).

For further explanations of the fundamentals here in eloquent and florid detail, please read ?Why I Sold Oil? and ?Why I?m Keeping My Oil Short?.

Do I Hear a Bid?

A Special Note on Exercised Options

Diary, Newsletter

There are only 13 days left to the options expiration on October 18. The Mad Hedge Fund Trader?s model trade portfolio has six positions that are deep in-the-money that expire that day. So, it is important that we tread carefully to get the bull benefit.

I received a few emails from readers whose option holdings have already been exercised against them, and have asked me for advice on how best to proceed. So, here we go.

The options traded on US exchanges and referred to in my Trade Alerts are American style, meaning that they can be exercised at any time by the owner. This is in contrast to European style options, which can only be exercised on the expiration day.

The call option spreads that I have been recommending for the past year are composed of a deep out-of-the-money long strike price plus a short portion at a near money strike price.

When stocks have high dividends, there is a chance that the near money option you are short gets exercised against you by the owner. This requires you to deliver the stock equivalent of the option you are short, plus any quarterly dividends that are due. Don?t worry, because your long position perfectly hedges you against this possibility.

You usually get notice of this assignment in an email after the close. You then need to email or call your broker back immediately informing him that you want to exercise your remaining long option position to meet your assigned short position.

This is a gift, as it means that you can realize the entire maximum theoretical profit of for the position without having to take the risk of running it all the way into expiration. You can either keep the cash, or pile on another sort dated option spread position and make even more money.

This should completely close out your position and leave you with a nice profit. This is not an automatic process and requires action on your part!

Assignments are made on a random basis by an exchange computer, and can happen any day. Exercise means the owner of the option that you are short completely loses all of the premium on his call.

Dividends have to be pretty high to make such a move economic, usually at least over 3% on an annual rate. But these days, markets are so efficient that traders, or their machines, will exercise options for a single penny profit.

Surprise assignments create a risk for option spread owners in a couple of ways. If you don?t check your email every day after the close, you might not be aware that you have been assigned. Alternatively, such emails sometimes get lost, or hung up in local servers or spam filters, which occasionally happens to readers of my own letter.

Then, you are left with the long side deep out-of-the-money call alone, which will have a substantially higher margin requirement. This is equivalent to going outright long the stock in large size.

This is a totally unhedged position now, and suddenly, you are playing a totally different game. If the stock then rises, you could be in for a windfall profit. But if it falls, you could take a big hit. Better to completely avoid this situation at all cost and not take the chance. You are probably not set up to do this type of trading.

If you don?t have the cash in your account to cover this, you could get a margin call. If you ignore this call as well, your broker will close out your position at market without your permission.

It could produce some disconcerting communications from your broker. They generally hate issuing margin calls, and could well close your account if it is too small to bother with, as they create regulatory issues.

It order to get belt and braces coverage on this issue, it is best to call your brokers and find out exactly what their assignment policies and procedures are. Believe it or not, some are still in the Stone Age, and have yet to automate the assignment process or give notice by email. An ounce of prevention could be worth a pound of cure here.

Consider all this a cost of doing business, or a frictional execution cost. In-the-money options are still a great strategy. But you should be aware of all the ins and outs to get the most benefit.

John Thomas

October 1, 2013

Diary, Newsletter, Summary

Global Market Comments
October 1, 2013
Fiat Lux

Featured Trade:
(JAPAN TO LAUNCH IRA?S),
(DXJ), (FXY), (YCS),
(KISS THAT UNION JOB GOODBYE)

WisdomTree Japan Hedged Equity (DXJ)
CurrencyShares Japanese Yen Trust (FXY)
ProShares UltraShort Yen (YCS)

Japan to Launch IRA?s

Newsletter

The Japanese government is about to introduce Individual Retirement Account for individual investors for the first time. The move is part of prime minister Shinzo Abe?s multifaceted efforts to revive Japan?s economy, and could unleash as much as $690 billion in net buying into Japanese equities by 2018.

The move was inspired American IRA?s, which were first introduced in 1981. After that, the Dow average soared 25 times. It is amazing to what lengths people will go to avoid the taxman.

Starting October 1, individuals will be permitted to contribute up to ?1 million a year into Nippon Individual Savings Accounts (NISA) or some $10,200, while married couples can chip in ?2 million. These funds will be exempt from capital gains and dividend taxes for five years. At the same time, capital gains taxes will rise from 10% to 20%.

Thanks to a 22-year long bear market, only 7.9% of personal assets in Japan are currently invested in stocks, compared to 34% in the US. Individuals account for only 28% of the daily trading volume in Tokyo, while foreigners take up 63%. Still, that?s up from only 21% a year earlier.

Over the past 10 years, individuals sold a net $214 billion in equities, keeping their eyes firmly on the rear view mirror. Almost all of the funds were deposited into bank accounts yielding near zero. Even 10 year Japanese Government Bonds are yielding only 0.68% as of today, the lowest on the planet. That doesn?t buy you much sushi in your retirement.

Over the past year, Japan has enjoyed the world?s fastest growing industrialized economy. The latest data show that it is expanding at a white hot 3.5%, versus a far more modest 2% rate in the US, and only 1% in Europe.

Early indications are that the NISA?s will be hugely popular. Japanese brokers have launched a massive advertising effort to promote the program, which promises to substantially boost their own earnings. Firms have had to lay on extra customer support staff to assist with online applications, where clueless investors have spent two decades in hiding.

To get some idea of the potential, take a look at how Merrill Lynch?s stock performed after 1981, which rose by many multiples. The bear market has lasted for so long that many applicants confess to investing in equities for the first time in their lives.

Since Shinzo Abe announced his candidacy for prime minister and his revolutionary economic and monetary program nearly a year ago, the Japanese stock market (DXJ) has soared by an amazing 80% in US dollar terms. The Japanese yen (FXY), (YCS) has similarly collapsed by a huge 25%.

The need to bolster Japan?s retirement finances is overwhelming. It has the world?s oldest population, with some 26% of their 127.6 million over the age of 65. The average life span in Japan is 82.6 years. That is a lot of people to support for a $6 trillion GDP. Thanks to plummeting fertility rates, the population is expected to decline to 106 million by 2055.

By yanking $690 billion out of the banks and moving out the risk spectrum, Abe?s new IRA?s provide additional means through which the economy can permanently return to health. Higher stock prices will provide cheap equity financing for public companies, which can then reinvest in the domestic economy and create jobs.

I have written endlessly on the fundamental case for a strong Japanese stock market this year (to read my previous articles on yen, please click the following links: ??Rumblings in Tokyo?, ?New BOJ Governor Craters Yen" and "New BOJ Governor Crushes the Yen").
And thank the US congress for behaving like such idiots. Their standoff is providing a decent entry point for a position here.

So How Does This Order App Work?

Kiss That Union Job Goodbye

Diary, Newsletter

Those of you counting on getting your old union assembly line job back in Detroit can forget it.

The eight year forecast published by the Bureau of Labor Statistics shows that 4.19 million jobs will be gained in the US in professional and business services, followed by 4 million health care and social assistance jobs, while 1.2 million will be lost in manufacturing.

This is great news for website designers, internet entrepreneurs, registered nurses, and masseuses in California, but grim tidings for traditional metal bashers in the rust belt manufacturing states like Michigan, Indiana, and Ohio.

I?m so old now that I am no longer asked for a driver?s license to get into a nightclub. Instead, they ask for a carbon dating. The real challenge for we aged career advisors is that probably half of these new service jobs haven?t even been invented yet, and if they can be described, it is only in a cheesy science fiction paperback with a half-dressed blond on the front cover. After all, who heard of a webmaster, a cell phone contract sales person, or a blogger 40 years ago?

Where are all these jobs going? You guessed it, China, which by my calculation, has imported 25 million jobs from the US over the past decade. You can also blame other lower waged, upstream manufacturing countries like Vietnam, where the Middle Kingdom is increasingly subcontracting its own offshoring.

These forecasts may be optimistic, because they assume that Americans can continue to claw their way up the value chain in the global economy, and not get stuck along the way, as the Japanese did in the nineties. The US desperately needs no less than 27 million new jobs to soak up natural population and immigration growth and get us back to a traditional 5% unemployment rate. The only way that is going to happen is for America to invent something new and big, and fast.

Personal computers achieved this during the eighties, and the internet did the trick in the nineties. The fact that we?ve done didly squat since 2000 except create a giant paper chase of subprime loans and derivatives explains why job growth since then has been zero, real wage growth has been negative, and American standards of living are falling.

Alternative energy and biotechnology are two possible drivers for a new economy. Unfortunately, the last administration did everything it could to stymie progress in both these fields, coddling big oil so China could steal a lead in several alternative technologies, and starving stem cell researchers of federal cash, ceding the lead there to others.

While the current crop of politicians extol the virtues of education, the reality is that we are dumbing down our public education system. How do we invent the next ?new? thing, while shrinking the University of California?s budget by 20% two years in a row? If my local high school can?t afford new computers, how is it going to feed Silicon Valley with computer literate work force? The US has a ?Michael Jackson? economy. It?s still living like a rock star, but hasn?t had a hit in 20 years.

China can have all the $20 a day jobs it wants. But if it accelerates its move up the value chain, as it clearly aspires to do, then America is in for even harder times. I?ll be hoping for the best, but preparing for the worst. How do you say ?unemployment check? in Mandarin?

September 30, 2013

Diary, Newsletter, Summary

Global Market Comments
September 30, 2013
Fiat Lux

Featured Trade:
(NOVEMBER 1 SAN FRANCISCO STRATEGY LUNCHEON),
(HAVE CALM WATERS RETURNED FOR SHIPPING STOCKS?),
($BDI), (DRYS), (SEA), (GNK),
(RIO), (BHP), (KOL), (FXA), (EWA)

Baltic Exchange Dry Index ($BDI)
DryShips, Inc. (DRYS)
Claymore/Delta Global Shipping (SEA)
Genco Shipping & Trading Ltd. (GNK)
Rio Tinto plc (RIO)
BHP Billiton Limited (BHP)
Market Vectors Coal ETF (KOL)
CurrencyShares Australian Dollar Trust (FXA)
iShares MSCI Australia Index (EWA)

November 1 San Francisco Strategy Luncheon

Diary, Lunch, Newsletter

Come join me for lunch at the Mad Hedge Fund Trader?s Global Strategy Update, which I will be conducting in San Francisco on Friday, November 1, 2013. An excellent meal will be followed by a wide-ranging discussion and an extended question and answer period.

I?ll be giving you my up to date view on stocks, bonds, currencies, commodities, precious metals, and real estate. And to keep you in suspense, I?ll be throwing a few surprises out there too. Tickets are available for $191.

I?ll be arriving at 11:00 and leaving late in case anyone wants to have a one on one discussion, or just sit around and chew the fat about the financial markets.

The lunch will be held at a private club in downtown San Francisco near Union Square that will be emailed with your purchase confirmation.

I look forward to meeting you, and thank you for supporting my research. To purchase tickets for the luncheons, please go to my online store.

Have Calm Waters Returned for Shipping Stocks?

Newsletter

Traders are stunned by the performance of the shipping stocks this month, which have been far and away a top market performer. The big questions they are now asking are ?Is it real?? and ?Is it sustainable??

This sector has been down for so long that most investors left it for dead a long time ago. All that was missing was the tolling of the Lutine Bell at the insurance exchange, Lloyds of London.

Lured by the heroin of artificially cheap financing during the naughts, the industry massively expanded capacity, believing that international trade would continue to grow at double digit rates forever. It didn?t.

Sound familiar? Think of it as ?subprime at sea.?

Then the 2008 financial crisis hit, and demand evaporated. International trade, the main driver of freight rates, collapsed. Freight rates dropped as much as 90%, and share prices even more. Readers delighted in sending me maps of laid up ships with forlorn crews in Singapore harbor, which at the worst, numbered in the hundreds. You could almost walk to neighboring Malaysia and not get your ankles wet.

For most industries, the economy bottomed shortly thereafter and began a long, slow recovery. Not so for shipping. China, the world?s largest buyer of bulk commodities, saw its economy peak in 2010, with annualized GDP growth halving since then from 13.5% to 7.5%.

This unleashed a second, even more vicious crisis for the shipping industry. With massive capital requirements, order times for new ships lasting three years, and hefty cancellation fees common, recovery delays are not what you want to hear about. Ships ordered at the peak of the financing bubble suddenly started showing up in large numbers. So, the industry remains with excess capacity of 20%, especially in the dry bulk, container, and crude oil tanker segments.

This was happening in the face of steadily rising fuel prices, thanks to events in Iran, Egypt, Libya, and Syria. The China slowdown also caused scrap metal rates to plummet, so downsizing shippers were paid less for junking their older, smaller, less fuel efficient ships. American energy independence, thanks to the ?fracking? boom, means fewer ships are needed to carry oil from a tempestuous Middle East.

It has been the perfect storm of perfect storms. All but seven of the 30 largest shipping companies bled money in 2012, lots of it. Cumulative industry losses amounted to a mind numbing $7 billion over the past four years. Companies continued to hemorrhage cash, and shareholders suffered.

And then a funny thing happened in August. The Chinese economic data slowly started to improve. Any price tied to business activity in the Middle Kingdom started marching upward in unison, including those for iron ore (BHP), (RIO), coal (KOL), the Australian dollar (FXA), and Chinese and Australian stocks (FXI), (EWA).

This improvement, no matter how uncertain it may be, was not lost on the shipping industry.? Capesize charter rates surged from $5,000 to $16,500, while Panamax rates are expected to fly from $8,000 to $9,500 by January. Shipping stocks, the most highly leveraged of asset classes, skyrocketed. This enabled the Baltic Dry Index ($BDI), a measure of the cost of chartering bulk carriers for coal, iron ore, wheat, and other dry commodities, to rise some 160% since July. Apparently, it is off to the races once again.

I am not normally a person who buys a stock after it has just doubled, unless Costco is running a special on Jack Daniels. But if a share has fallen 99%, a double takes it to down only 98%, leaving it still absurdly cheap. Shipping stocks fell so far, they were well below long dated option value. That means the market thought all of these guys were going under, which was never going to happen.

This is certainly the case with Dry Ships (DRYS), your poster boy for the Greek shipping industry. Adjusted for splits, the shares cratered from $120 to $1.50. It has just clawed its way up to $4.00, and then backed off to $3.67. The company?s fleet consists of 38 dry bulk carriers, 10 tankers, and has orders for another four ships.

It has completed a major refinancing that takes the firm out of the fire and puts it back into the frying pan. This should buy (DRYS) some time, while other competitors, like Genco Shipping and Trading (GNK) are expected to go under, removing unwanted overcapacity from the market. It also wisely diversified into offshore oil drilling right at the bottom of the market, picking up a 59% stake in Ocean Rig (ORIG) and its two semisubmersible rigs.

(DRYS) is not your typical ?widows and orphans? type investment. The web is chocked full of allegations of insider trading, nepotism and self-dealing by senior management. It is domiciled in the Marshall Islands, so don?t expect much transparency. Pass the smell test, it does not. After all, it is a Greek company.

If (DRYS) scares you and it should, there are safer ways to play the rebound. The Guggenheim Shipping ETF (SEA) offers a broad mix of industry exposure with lower volatility. It is up only 25% since April.

Even in the best-case scenario, shipping will never return to the heady growth rates of the naughts. China is highly unlikely to ever return to the breakneck growth rates of yore. The law of large numbers is kicking in with a vengeance.

It is modernizing its economic strategy, from a low value added commodity export led one, to a more domestically driven, services oriented approach. The bad news for shippers: The new model uses fewer bulk commodities, and therefore the ships to carry them.

However, if the China recovery is real, even a modest one, then the shipping industry offers one of the best multiple baggers that I can think of.

Just make sure you don?t get seasick from the volatility.

The Lutine Bell

September 27, 2013

Diary, Newsletter, Summary

Global Market Comments
September 27, 2013
Fiat Lux

Featured Trade:
(GOING BACK INTO JAPAN),
(DXJ), ($NIKK), (FXY), (YCS),
(BE CAREFUL, YOUR PC IS WATCHING)

WisdomTree Japan Hedged Equity (DXJ)
Nikkei Index ($NIKK)
CurrencyShares Japanese Yen Trust (FXY)
ProShares UltraShort Yen (YCS)

Going Back Into Japan

Newsletter

The smart people I know believe that prime minister Shinzo Abe?s plans to revive the Japanese economy will succeed, paving the way for a decade long bull market that will take the Nikkei Index ($NIKK) up to new highs. The dumb people I know argue vociferously and passionately that Abe will fail miserably, and that the economy and stocks will crash and burn as early as next year.

I think I?ll go with the smart people.

Last night, we learned that Japan?s Government Pension Investment Fund (GPIF) is going to carry out a massive reallocation out of domestic government bonds and into risk assets. The move not only sent Japanese shares flying, it has major implications for US and European markets as well.

The GPIF is the world?s largest pension investor, with a staggering $1.23 trillion in assets. It will boost its allocation to domestic shares from 11% to 12%, unleashing $12 billion in net stock buying. A far more impressive $37 billion has been earmarked for foreign stock markets. This will come at the expense of bonds, which will see their share cut back from 67% to 60%.

The move was triggered by the terrible performance of the Japanese government bond market this year, which has seen prices plunge and yields soar. Since the 2012 lows, the ten-year JGB yield has ratcheted up from an unbelievably low 0.39% to as high as 1.20%, a threefold increase. This dragged down the overall return on investment for the GPIF to the lowest levels in history. Since the demands by Japan?s retirees are expected to skyrocket from here, the fund had little choice but to move out substantially on the risk spectrum.

This is most likely only the opening salvo of the multiyear Great Rotation by the GPIF out of bonds and into stocks globally. The GPIF is not only attracted by the far higher dividend yields and capital gains offered by foreign stocks. A weakening Japanese yen will also juice profits when translated back to the home currency.

In the meantime, it is pedal to the metal for Mr. Shinzo Abe, whose late father, Shintaro, I knew well. He is betting the future of the country on a potent, and unprecedented, mix of fiscal stimulus, monetary easing and deregulation. The Bank of Japan has been leading the charge here, targeting a 2% inflation rate in two years, and promising to double the money supply. My own forecast is that this package will eventually take the Japanese yen down from today?s ?99 to ?150 to the dollar.

If you are an old fart like me you will recognize this approach. President Ronald Reagan employed a similar strategy to get the US economy off the mat in the wake of the 1974 and 1980 oil crisis and the stagflation that followed. This paved the way for a move in the Dow Average from 600 to 15,000. Nope, newbies, that is not typo. It really happened. If nothing else, the Japanese are great students of history, perhaps better than we are.

The other incentive to make a move on the (DXJ) here is that a further move down in the Japanese yen (FXY), (YCS) is imminent. It has been hovering just below ?100 for six months now, and is on the verge of launching into a new leg down. All that has been missing until now has been the trigger for the break. The GPIF move could be it.

I have written endlessly on the fundamental case for a weak yen for the past two years (for a link why you should sell short the yen, please click here http://madhedgefundradio.com/rumblings-in-tokyo-2/, ?and here http://madhedgefundradio.com/new-boj-governor-craters-yen/, and finally one more http://madhedgefundradio.com/new-boj-governor-crushes-the-yen/.