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Why Are Bond Yields So Low?

Investors around the world have been confused, befuddled and surprised by the persistent, ultra low level of long term interest rates in the United States.

At today?s close, the 30 year Treasury bond yielded a parsimonious 2.01%, the ten year, 2.62%, and the five year only 1.51%. The ten-year was threatening its all time low yield of 1.37% only two weeks ago, a return as rare as a dodo bird, last seen in August, 2012.

What?s more, yields across the entire fixed income spectrum have been plumbing new lows. Corporate bonds (LQD) have been fetching only 3.29%, tax-free municipal bonds (MUB) 2.89%, and junk (JNK) a pittance at 5.96%.

Spreads over Treasuries are approaching new all time lows. The spread for junk over of ten year Treasuries is now below an amazing 3.00%, a heady number not seen since the 2007 bubble top. ?Covenant light? in borrower terms is making a big comeback.

Are investors being rewarded for taking on the debt of companies that are on the edge of bankruptcy, a tiny 3.3% premium? I think not.

It is a global trend.

German bunds are now paying holders 0.35%, and JGB?s are at an eye popping 0.30%. The worst quality southern European paper has delivered the biggest rallies this year. Portuguese government paper is paying only 2.40%, and is rapidly closing in on US government yields.

Yikes!

These numbers indicate that there is a massive global capital glut. There is too much money chasing too few low risk investments everywhere. Has the world suddenly become risk averse? Is inflation gone forever? Will deflation become a permanent aspect of our investing lives? Does the reach for yield know no bounds?

It wasn?t supposed to be like this.

Almost to a man, hedge fund managers everywhere were unloading debt instruments in January. They were looking for a year of rising interest rates (TLT), accelerating stock prices (QQQ), falling commodities (DBA), and dying emerging markets (EEM). Surging capital inflows were supposed to prompt the dollar (UUP) to take off like a rocket.

It all ended up being almost a perfect mirror image portfolio of what actually transpired since then. As a result, almost all mutual funds are down so far in 2014. Many hedge fund managers are tearing their hair out, suffering their worst year in recent memory.

What is wrong with this picture?

Interest rates like these are hinting that the global economy is about to endure a serious nose dive, possibly even re-entering recession territory?or it isn?t.

To understand why not, we have to delve into deep structural issues, which are changing the nature of the debt markets beyond all recognition. This is not your father?s bond market.

I?ll start with what I call the ?1% effect.?

Rich people are different than you and I. Once they finally make their billions, they quickly evolve from being risk takers into wealth preservers. They don?t invest in start-ups, take fliers on stock tips, invest in the flavor of the day, or create jobs. In fact, many abandon shares completely, retreating to the safety of coupon clipping.

The problem for the rest of us is that this capital stagnates. It goes into the bond market where it stays forever. These people never sell, thus avoiding capital gains taxes and capturing a future step up in the cost basis whenever a spouse dies. Only the interest payments are taxable and that at a lowly 20% rate.

This is the lesson I learned from servicing generations of Rothschild?s, Du Ponts, Rockefellers, and Getty. Extremely wealthy families stay that way by becoming extremely conservative investors. Those that don?t, you?ve never heard of, because they all eventually went broke.

This didn?t used to mean much before 1980, back when the wealthy only owned 10% of the bond market, except to financial historians and private wealth specialists, of which I am one. Now they own a whopping 23%, and their behavior affects everyone.

Who has bee the largest buyer of Treasury bonds for the last 30 years? Foreign central banks and other governmental entities, which count them among their country?s foreign exchange reserves. They own 36% of our national debt, with China in the lead at 8% (the Bush tax cut that was borrowed), and Japan close behind with 7% (the Reagan tax cut that was borrowed). These days they purchase about 50% of every Treasury auction.

They never sell either, unless there is some kind of foreign exchange or balance of payments crisis, which is rare. If anything, these holdings are still growing.

Who else has been soaking up bonds, deaf to repeated cries that prices are about to plunge? The Federal Reserve, which thanks to QE1, 2, and 3, now owns 22% of our $17 trillion debt. Both the former Federal Reserve governor Ben Bernanke, and the present one, Janet Yellen, have made clear they have no plans to sell these bonds. They will run them to maturity instead, minimizing the market impact.

An assortment of other government entities possess a further 29% of US government bonds, first and foremost the Social Security Administration, with a 16% holding. And they ain?t selling either, baby.

So what you have here is the overwhelming majority of Treasury bond owners with no intention to sell. Only hedge funds have been selling this year, and they have already done so, in spades.

Which sets up a frightening possibility for them, now that we are at the very bottom of the past year?s range in yields. What happens if bond yields fall further? It will set off the mother of all short covering squeezes and could take ten-year yield down to match the 2012, 2.38% low.

Fasten your seat belts, batten the hatches, and down the Dramamine!

There are a few other reasons why rates will stay at subterranean levels for some time. If hyper accelerating technology keeps cutting costs for the rest of the century, deflation basically never goes away (click here?for ?Peeking into the Future with Ray Kurzweil?).

Hyper accelerating corporate profits will also create a global cash glut, further levitating bond prices. Companies are becoming so profitable they are throwing off more cash then they can reasonably use or pay out.

This is why these gigantic corporate cash hoards are piling up in Europe in tax free jurisdictions, now over $2 trillion. Is the US heading for Japanese style yields, or 0.39% for 10 year Treasuries?

If so, bonds are a steal here at 2.55%. If we really do enter a period of long term -2% a year deflation, that means the purchasing power of a dollar increases by 35% every decade in real terms.

The threat of a second Cold War is keeping the flight to safety bid alive, and keeping the bull market for bonds percolating. This could put a floor under bond prices for another decade, and Vladimir Putin?s current presidential run could last all the way under 2014.

All of this is why I?m out of the bond market for now, and will remain so for a while.

Who Owns U.S. Debt

TLT 2-13-15

MUB 2-13-15+

JNK 2-13-15

OrangutanWhy Are They So Low?

2015 Annual Asset Class Review

Zephyr

I am once again writing this report from a first class sleeping cabin on Amtrak?s California Zephyr. By day, I have two comfortable seats facing each other next to a broad window. At night, they fold into bunk beds, a single and a double. There is a shower, but only Houdini could get in and out of it.

We are now pulling away from Chicago?s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I am headed for Emeryville, California, just across the bay from San Francisco. That gives me only 56 hours to complete this report.

I tip my porter, Raymond, $100 in advance to make sure everything goes well during the long adventure, and to keep me up to date with the onboard gossip.

The rolling and pitching of the car is causing my fingers to dance all over the keyboard. Spellchecker can catch most of the mistakes, but not all of them. Thank goodness for small algorithms.

 

station

As both broadband and cell phone coverage are unavailable along most of the route, I have to rely on frenzied searches during stops at major stations along the way to chase down data points.

You know those cool maps in the Verizon stores that show the vast coverage of their cell phone networks? They are complete BS. Who knew that 95% of America is off the grid? That explains a lot about our politics today. I have posted many of my better photos from the trip below, although there is only so much you can do from a moving train and an iPhone.

After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2014 was one of the toughest to trade for careers lasting 30, 40, or 50 years. Yet again, the stay at home index players have defeated the best and the brightest.

With the Dow gaining a modest 8% in 2014, and S&P 500 up a more virile 14.2%, this was a year of endless frustration. Volatility fell to the floor, staying at a monotonous 12% for seven boring consecutive months. Most hedge funds lagged the index by miles.

My Trade Alert Service, hauled in an astounding 30.3% profit, at the high was up 42.7%, and has become the talk of the hedge fund industry. That was double the S&P 500 index gain.

If you think I spend too much time absorbing conspiracy theories from the Internet, let me give you a list of the challenges I see financial markets facing in the coming year:

 

JT & conductor

The Ten Highlights of 2015

1) Stocks will finish 2015 higher, almost certainly more than the previous year, somewhere in the 10-15% range. Cheap energy, ultra low interest rates, and 3-4% GDP growth, will expand multiples. It?s Goldilocks with a turbocharger.

2) Performance this year will be back-end loaded into the fourth quarter, as it was in 2014. The path forward became so clear, that some of 2015?s performance was pulled forward into November, 2014.

3) The Treasury bond market will modestly grind down, anticipating the inevitable rate rise from the Federal Reserve.

4) The yen will lose another 10%-20% against the dollar.

5) The Euro will fall another 10%, doing its best to hit parity with the greenback, with the assistance of beleaguered continental governments.

6) Oil stays in a $50-$80 range, showering the economy with hundreds of billions of dollars worth of de facto tax cuts.

7) Gold finally bottoms at $1,000 after one more final flush, then rallies (My jeweler was right, again).

8) Commodities finally bottom out, thanks to new found strength in the global economy, and begin a modest recovery.

9) Residential real estate has made its big recovery, and will grind up slowly from here.

10) After a tumultuous 2014, international political surprises disappear, the primary instigators of trouble becalmed by collapsed oil revenues.

 

windmills

The Thumbnail Portfolio

Equities – Long. A rising but low volatility year takes the S&P 500 up to 2,350. This year we really will get another 10% correction. Technology, biotech, energy, solar, and financials lead.

Bonds – Short. Down for the entire year with long periods of stagnation.

Foreign Currencies – Short. The US dollar maintains its bull trend, especially against the Yen and the Euro.

Commodities – Long. A China recovery takes them up eventually.

Precious Metals – Stand aside. We get the final capitulation selloff, then a rally.

Agriculture – Long. Up, because we can?t keep getting perfect weather forever.

Real estate – Long. Multifamily up, commercial up, single family homes sideways to up small.

 

farmland

1) The Economy – Fortress America

This year, it?s all about oil, whether it stays low, shoots back up, or falls lower. The global crude market is so big, so diverse, and subject to so many variables, that it is essentially unpredictable.

No one has an edge, not the major producers, consumers, or the myriad middlemen. For proof, look at how the crash hit so many ?experts? out of the blue.

This means that most economic forecasts for the coming year are on the low side, as they tend to be insular and only examine their own back yard, with most predictions still carrying a 2% handle.

I think the US will come in at the 3%-4% range, and the global recovery spawns a cross leveraged, hockey stick effect to the upside. This will be the best performance in a decade. Most company earnings forecasts are low as well.

There is one big positive that we can count on in the New Year. Corporate earnings will probably come in at $130 a share for the S&P 500, a gain of 10% over the previous year. During the last five years, we have seen the most dramatic increase in earnings in history, taking them to all-time highs.

This is set to continue. Furthermore, this growth will be front end loaded into Q1. The ?tell? was the blistering 5% growth rate we saw in Q3, 2014.

Cost cutting through layoffs is reaching an end, as there is no one left to fire. That leaves hyper accelerating technology and dramatically lower energy costs the remaining sources of margin increases, which will continue their inexorable improvements. Think of more machines and software replacing people.

You know all of those hundreds of billions raised from technology IPO?s in 2014. Most of that is getting plowed right back into new start ups, accelerating the rate of technology improvements even further, and the productivity gains that come with it.

You can count on demographics to be a major drag on this economy for the rest of the decade. Big spenders, those in the 46-50 age group, don?t return in large numbers until 2022.

But this negative will be offset by a plethora of positives, like technology, global expansion, and the lingering effects of Ben Bernanke?s massive five year quantitative easing. A time to pay the piper for all of this largess will come. But it could be a decade off.

I believe that the US has entered a period of long-term structural unemployment similar to what Germany saw in the 1990?s. Yes, we may grind down to 5%, but no lower than that. Keep close tabs on the weekly jobless claims that come out at 8:30 AM Eastern every Thursday for a good read as to whether the financial markets will head in a ?RISK ON? or ?RISK OFF? direction.

Most of the disaster scenarios predicted for the economy this year were based on the one off black swans that never amounted to anything, like the Ebola virus, ISIS, and the Ukraine.

Being continually afraid is expensive.

 

Moose on Snowy MountainA Rocky Mountain Moose Family

 

2) Equities (SPX), (QQQ), (AAPL), (XLF), (BAC), (EEM),(EWZ), (RSX), (PIN), (FXI), (TUR), (EWY), (EWT), (IDX)

With the economy going gangbusters, and corporate earnings reaching $130 a share, those with a traditional ?buy and hold? approach to the stock market will do alright, provided they are willing to sleep through some gut churning volatility. A Costco sized bottle of Jack Daniels and some tranquillizers might help too.

Earnings multiples will increase as well, as much as 10%, from the current 17X to 18.5X, thanks to a prolonged zero interest rate regime from the Fed, a massive tax cut in the form of cheap oil, unemployment at a ten year low, and a paucity of attractive alternative investments.

This is not an outrageous expectation, given the 10-22 earnings multiple range that we have enjoyed during the last 30 years. If anything, it is amazing how low multiples are, given the strong tailwinds the economy is enjoying.

The market currently trades around fair value, and no market in history ever peaked out here. An overshoot to the upside, often a big one, is mandatory.
After all, my friend, Janet Yellen, is paying you to buy stock with cheap money, so why not?

This is how the S&P 500 will claw its way up to 2,350 by yearend, a gain of about 12.2% from here. Throw in dividends, and you should pick up 14.2% on your stock investments in 2015.

This does not represent a new view for me. It is simply a continuation of the strategy I outlined again in October, 2014 (click here for ?Why US Stocks Are Dirt Cheap?).

Technology will be the top-performing sector once again this year. They will be joined by consumer cyclicals (XLV), industrials (XLI), and financials (XLF).

The new members in the ?Stocks of the Month Club? will come from newly discounted and now high yielding stocks in the energy sector (XLE).

There is also a rare opportunity to buy solar stocks on the cheap after they have been unfairly dragged down by cheap oil like Solar City (SCTY) and the solar basket ETF (TAN). Revenues are rocketing and costs are falling.

After spending a year in the penalty box, look for small cap stocks to outperform. These are the biggest beneficiaries of cheap energy and low interest rates, and also have minimal exposure to the weak European and Asian markets.

Share prices will deliver anything but a straight-line move. We finally got our 10% correction in 2014, after a three-year hiatus. Expect a couple more in 2015. The higher prices rise, the more common these will become.

We will start with a grinding, protesting rally that takes us up to new highs, as the market climbs the proverbial wall of worry. Then we will suffer a heart stopping summer selloff, followed by another aggressive yearend rally.

Cheap money creates a huge incentive for companies to buy back their own stock. They divert money from their $3 trillion cash hoard, which earns nothing, retire shares paying dividends of 3% or more, and boost earnings per share without creating any new business. Call it financial engineering, but the market loves it.

Companies are also retiring stock through takeovers, some $2 trillion worth last year. Expect more of this to continue in the New Year, with a major focus on energy. Certainly, every hedge fund and activist investor out there is undergoing a crash course on oil fundamentals. After a 13-year bull market in energy, the industry is ripe for a cleanout.

This is happening in the face of both an individual and institutional base that is woefully underweight equities.

The net net of all of this is to create a systemic shortage of US equities. That makes possible simultaneous rising prices and earnings multiples that have taken us to investor heaven.

 

SPX 12-31-14

QQQ 12-31-14

IWM 12-31-14

XLE 12-31-14

snowy hillsFrozen Headwaters of the Colorado River

 

3) Bonds ?(TLT), (TBT), (JNK), (PHB), (HYG), (PCY), (MUB), (HCP), (KMP), (LINE)

Amtrak needs to fill every seat in the dining car, so you never know who you will get paired with.

There was the Vietnam vet Phantom jet pilot who now refused to fly because he was treated so badly at airports. A young couple desperate to get out of Omaha could only afford seats as far as Salt Lake City, sitting up all night. I paid for their breakfast.

A retired British couple was circumnavigating the entire US in a month on a ?See America Pass.? Mennonites returning home by train because their religion forbade airplanes.

If you told me that US GDP growth was 5%, unemployment was at a ten year low at 5.8%, and energy prices had just halved, I would have pegged the ten-year Treasury bond yield at 6.0%. Yet here we are at 2.10%.

Virtually every hedge fund manager and institutional investor got bonds wrong last year, expecting rates to rise. I was among them, but that is no excuse. At least I have good company.

You might as well take your traditional economic books and throw them in the trash. Apologies to John Maynard Keynes, John Kenneth Galbraith, and Paul Samuelson.

The reasons for the debacle are myriad, but global deflation is the big one. With ten year German bunds yielding a paltry 50 basis points, and Japanese bonds paying a paltry 30 basis points, US Treasuries are looking like a bargain.

To this, you can add the greater institutional bond holding requirements of Dodd-Frank, a balancing US budget deficit, a virile US dollar, the commodity price collapse, and an enormous embedded preference for investors to keep buying whatever worked yesterday.

For more depth on the perennial strength of bonds, please click here for ?Ten Reasons Why I?m Wrong on Bonds?.

Bond investors today get an unbelievable bad deal. If they hang on to the longer maturities, they will get back only 80 cents worth of purchasing power at maturity for every dollar they invest.

But institutions and individuals will grudgingly lock in these appalling returns because they believe that the potential losses in any other asset class will be worse. The problem is that driving eighty miles per hour while only looking in the rear view mirror can be hazardous to your financial health.

While much of the current political debate centers around excessive government borrowing, the markets are telling us the exact opposite. A 2%, ten-year yield is proof to me that there is a Treasury bond shortage, and that the government is not borrowing too much money, but not enough.

There is another factor supporting bonds that no one is looking at. The concentration of wealth with the 1% has a side effect of pouring money into bonds and keeping it there. Their goal is asset protection and nothing else.

These people never sell for tax reasons, so the money stays there for generations. It is not recycled into the rest of the economy, as conservative economists insist. As this class controls the bulk of investable assets, this forestalls any real bond market crash, possibly for decades.

So what will 2015 bring us? I think that the erroneous forecast of higher yields I made last year will finally occur this year, and we will start to chip away at the bond market bubble?s granite edifice. I am not looking for a free fall in price and a spike up in rates, just a move to a new higher trading range.

The high and low for ten year paper for the past nine months has been 1.86% to 3.05%. We could ratchet back up to the top end of that range, but not much higher than that. This would enable the inverse Treasury bond bear ETF (TBT) to reverse its dismal 2014 performance, taking it from $46 back up to $76.

You might have to wait for your grandchildren to start trading before we see a return of 12% Treasuries, last seen in the early eighties. I probably won?t live that long.

Reaching for yield will continue to be a popular strategy among many investors, which is typical at market tops. That focuses buying on junk bonds (JNK) and (HYG), REITS (HCP), and master limited partnerships (KMP), (LINE).

There is also emerging market sovereign debt to consider (PCY). At least there, you have the tailwinds of long term strong economies, little outstanding debt, appreciating currencies, and higher interest rates than those found at home. This asset class was hammered last year, so we are now facing a rare entry point. However, keep in mind, that if you reach too far, your fingers get chopped off.

There is a good case for sticking with munis. No matter what anyone says, taxes are going up, and when they do, this will increase tax free 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, and mark to markets could be shocking. Be sure to consult with a local financial advisor to max out the state, county, and city tax benefits.

 

TLT 12-31-14

TBT 12-31-14

MennonitesA Visit to the 19th Century

 

4) Foreign Currencies (FXE), (EUO), (FXC), (FXA), (YCS), (FXY), (CYB)

There are only three things you need to know about trading foreign currencies in 2015: the dollar, the dollar, and the dollar. The decade long bull market in the greenback continues.

The chip shot here is still to play the Japanese yen from the short side. Japan?s Ministry of Finance is now, far and away, the most ambitious central bank hell bent on crushing the yen to rescue its dying economy.

The problems in the Land of the Rising Sun are almost too numerous to count: the world?s highest debt to GDP ratio, a horrific demographic problem, flagging export competitiveness against neighboring China and South Korea, and the world?s lowest developed country economic growth rate.

The dramatic sell off we saw in the Japanese currency since December, 2012 is the beginning of what I believe will be a multi decade, move down. Look for ?125 to the dollar sometime in 2015, and ?150 further down the road. I have many friends in Japan looking for and overshoot to ?200. Take every 3% pullback in the greenback as a gift to sell again.

With the US having the world?s strongest major economy, its central bank is, therefore, most likely to raise interest rates first. That translates into a strong dollar, as interest rate differentials are far and away the biggest decider of the direction in currencies. So the dollar will remain strong against the Australian and Canadian dollars as well.

The Euro looks almost as bad. While European Central Bank president, Mario Draghi, has talked a lot about monetary easing, he now appears on the verge of taking decisive action.

Recurring financial crisis on the continent is forcing him into a massive round of Fed style quantitative easing through the buying of bonds issued by countless European entities. The eventual goal is to push the Euro down to parity with the buck and beyond.

For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book, but don?t expect more than single digit returns. The Middle Kingdom will move heaven and earth in order to keep its appreciation modest to maintain their crucial export competitiveness.

 

FXY 1-2-15

FXE 1-5-15

CYB 1-2-15

mountains

5) Commodities (FCX), (VALE), (MOO), (DBA), (MOS), (MON), (AGU), (POT), (PHO), (FIW), (CORN), (WEAT), (SOYB), (JJG)

There isn?t a strategist out there not giving thanks for not loading up on commodities in 2014, the preeminent investment disaster of 2015. Those who did are now looking for jobs on Craig?s List.

2014 was the year that overwhelming supply met flagging demand, both in Europe and Asia. Blame China, the big swing factor in the global commodity.

The Middle Kingdom is currently changing drivers of its economy, from foreign exports to domestic consumption. This will be a multi decade process, and they have $4 trillion in reserves to finance it.

It will still demand prodigious amounts of imported commodities, especially, oil, copper, iron ore, and coal, all of which we sell. But not as much as in the past. The derivative equity plays here, Freeport McMoRan (FCX) and Companhia Vale do Rio Doce (VALE), have all taken an absolute pasting.

The food commodities were certainly the asset class to forget about in 2014, as perfect weather conditions and over planting produced record crops for the second year in a row, demolishing prices. The associated equity plays took the swan dive with them.

However, the ags are still a tremendous long term Malthusian play. The harsh reality here is that the world is making people faster than the food to feed them, the global population jumping from 7 billion to 9 billion by 2050.

Half of that increase comes in countries unable to feed themselves today, largely in the Middle East. The idea here is to use any substantial weakness, as we are seeing now, to build long positions that will double again if global warming returns in the summer, or if the Chinese get hungry.

The easy entry points here are with the corn (CORN), wheat (WEAT), and soybeans (SOYB) ETF?s. You can also play through (MOO) and (DBA), and the stocks Mosaic (MOS), Monsanto (MON), Potash (POT), and Agrium (AGU).

The grain ETF (JJG) is another handy fund. Though an unconventional commodity play, the impending shortage of water will make the energy crisis look like a cakewalk. You can participate in this most liquid of assets with the ETF?s (PHO) and (FIW).

 

CORN 1-2-15

DBA 1-2-15

PHO 1-2-15

JT snow angelSnow Angel on the Continental Divide

 

6) Energy (DIG), (RIG), (USO), (DUG), (DIG), (UNG), (USO), (OXY), (XLE), (X)

Yikes! What a disaster! Energy in 2014 suffered price drops of biblical proportions. Oil lost the $30 risk premium it has enjoyed for the last ten years. Natural gas got hammered. Coal disappeared down a black hole.

Energy prices did this in the face of an American economy that is absolutely rampaging, its largest consumer.

Our train has moved over to a siding to permit a freight train to pass, as it has priority on the Amtrak system. Three Burlington Northern engines are heaving to pull over 100 black, brand new tank cars, each carrying 30,000 gallons of oil from the fracking fields in North Dakota.

There is another tank car train right behind it. No wonder Warren Buffett tap dances to work every day, as he owns the road. US Steel (X) also does the two-step, since they provide immense amounts of steel to build these massive cars.

The US energy boom sparked by fracking will be the biggest factor altering the American economic landscape for the next two decades. It will flip us from a net energy importer to an exporter within two years, allowing a faster than expected reduction in military spending in the Middle East.

Cheaper energy will bestow new found competitiveness on US companies that will enable them to claw back millions of jobs from China in dozens of industries. This will end our structural unemployment faster than demographic realities would otherwise permit.

We have a major new factor this year in considering the price of energy. Peace in the Middle East, especially with Iran, always threatened to chop $30 off the price of Texas tea. But it was a pie-in-the-sky hope. Now there are active negotiations underway in Geneva for Iran to curtail or end its nuclear program. This could be one of the black swans of 2015, and would be hugely positive for risk assets everywhere.

Enjoy cheap oil while it lasts because it won?t last forever. American rig counts are already falling off a cliff and will eventually engineer a price recovery.

Add the energies of oil (DIG), Cheniere Energy (LNG), the energy sector ETF (XLE), Conoco Phillips (COP), and Occidental Petroleum (OXY). Skip natural gas (UNG) price plays and only go after volume plays, because the discovery of a new 100-year supply from ?fracking? and horizontal drilling in shale formations is going to overhang this subsector for a very long time.

It is a basic law of economics that cheaper prices bring greater demand and growing volumes, which have to be transported. However, major reforms are required in Washington before use of this molecule goes mainstream.

These could be your big trades of 2015, but expect to endure some pain first.

 

Baker Hughes Rig Count

WTIC 1-2-15

UNG 1-2-15

OXY 1-2-15

Train

7) Precious Metals (GLD), (DGP), (SLV), (PPTL), (PALL)

The train has added extra engines at Denver, so now we may begin the long laboring climb up the Eastern slope of the Rocky Mountains.

On a steep curve, we pass along an antiquated freight train of hopper cars filled with large boulders. The porter tells me this train is welded to the tracks to create a windbreak. Once, a gust howled out of the pass so swiftly that it blew a train over on to its side.

In the snow filled canyons we sight a family of three moose, a huge herd of elk, and another group of wild mustangs. The engineer informs us that a rare bald eagle is flying along the left side of the train. It?s a good omen for the coming year. We also see countless abandoned gold mines and the broken down wooden trestles leading to them, so it is timely here to speak about precious metals.

As long as the world is clamoring for paper assets like stocks and bonds, gold is just another shiny rock. After all, who needs an insurance policy if you are going to live forever?

We have already broken $1,200 once, and a test of $1,000 seems in the cards before a turnaround ensues. There are more hedge fund redemptions and stop losses to go. The bear case has the barbarous relic plunging all the way down to $700.

But the long-term bull case is still there. Someday, we are going to have to pay the piper for the $4.5 trillion expansion in the Fed?s balance sheet over the past five years, and inflation will return. Gold is not dead; it is just resting. I believe that the monetary expansion arguments to buy gold prompted by massive quantitative easing are still valid.

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. The precious metals have to work off a severely, decade old overbought condition before we make substantial new highs. Remember, this is the asset class that takes the escalator up and the elevator down, and sometimes the window.

If the institutional world devotes just 5% of their assets to a weighting in gold, 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 more.

This is why emerging market central banks step in as large buyers every time we probe lower prices. For me, that pegs the range for 2015 at $1,000-$1,400. 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 once more, and eventually $100.

What will be the metals to own in 2015? Palladium (PALL) and platinum (PPLT), which have their own auto related long term fundamentals working on their behalf, would be something to consider on a dip. With US auto production at 17 million units a year and climbing, up from a 9 million low in 2009, any inventory problems will easily get sorted out.

 

GOLD 1-2-15

SILVER 1-2-15

sunsetWould You Believe This is a Blue State?

8) Real Estate (ITB)

The majestic snow covered Rocky Mountains are behind me. There is now a paucity of scenery, with the endless ocean of sagebrush and salt flats of Northern Nevada outside my window, so there is nothing else to do but write. My apologies to readers in Wells, Elko, Battle Mountain, and Winnemucca, Nevada.

It is a route long traversed by roving banks of Indians, itinerant fur traders, the Pony Express, my own immigrant forebears in wagon trains, the transcontinental railroad, the Lincoln Highway, and finally US Interstate 80.

There is no doubt that there is a long-term recovery in real estate underway. We are probably 8 years into an 18-year run at the next peak in 2024.

But the big money has been made here over the past two years, with some red hot markets, like San Francisco, soaring. If you live within commuting distance of Apple (AAPL), Google (GOOG), or Facebook (FB) headquarters in California, you are looking at multiple offers, bidding wars, and prices at all time highs.

From here on, I expect a slow grind up well into the 2020?s. If you live in the rest of the country, we are talking about small, single digit gains. The consequence of pernicious deflation is that home prices appreciate at a glacial pace. At least, it has stopped going down, which has been great news for the financial industry.

There are only three numbers you need to know in the housing market: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 85 million in the generation after that, the Millennials.

The boomers have been unloading dwellings to the Gen Xer?s since prices peaked in 2007. But there are not enough of the latter, and three decades of falling real incomes mean that they only earn a fraction of what their parents made.

If they have prospered, banks won?t lend to them. Brokers used to say that their market was all about ?location, location, location?. Now it is ?financing, financing, financing?. Banks have gone back to the old standard of only lending money to people who don?t need it.

Consider the coming changes that will affect this market. The home mortgage deduction is unlikely to survive any real attempt to balance the budget. And why should renters be subsidizing homeowners anyway? Nor is the government likely to spend billions keeping Fannie Mae and Freddie Mac alive, which now account for 95% of home mortgages.

That means the home loan market will be privatized, leading to mortgage rates higher than today. It is already bereft of government subsidies, so loans of this size are priced at premiums. This also means that the fixed rate 30-year loan will go the way of the dodo, as banks seek to offload duration risk to consumers. This happened long ago in the rest of the developed world.

There is a happy ending to this story. By 2022 the Millennials will start to kick in as the dominant buyers in the market. Some 85 million Millennials will be chasing the homes of only 65 Gen Xer?s, causing housing shortages and rising prices.

This will happen in the context of a labor shortfall and rising standards of living. Remember too, that by then, the US will not have built any new houses in large numbers in 15 years.

The best-case scenario for residential real estate is that it gradually moves up for another decade, unless you live in Cupertino or Mountain View. We won?t see sustainable double-digit gains in home prices until America returns to the Golden Age in the 2020?s, when it goes hyperbolic.

But expect to put up your first-born child as collateral, and bring your entire extended family in as cosigners if you want to get a bank loan.

That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with. This is especially true if you lock up today?s giveaway interest rates with a 30 year fixed rate loan. At 3.3% this is less than the long-term inflation rate.

You will boast about it to your grandchildren, as my grandparents once did to me.

 

Case-Shiller Home Prices Indices

ITB 1-2-15

BridgeCrossing the Bridge to Home Sweet Home

9) Postscript

We have pulled into the station at Truckee in the midst of a howling blizzard.

My loyal staff have made the 20 mile trek from my beachfront estate at Incline Village to welcome me to California with a couple of hot breakfast burritos and a chilled bottle of Dom Perignon Champagne, which has been resting in a nearby snowbank. I am thankfully spared from taking my last meal with Amtrak.

Well, that?s all for now. We?ve just passed the Pacific mothball fleet moored in the Sacramento River Delta and we?re crossing the Benicia Bridge. The pressure increase caused by an 8,200 foot descent from Donner Pass has crushed my water bottle. The Golden Gate Bridge and the soaring spire of the Transamerica Building are just around the next bend across San Francisco Bay.

A storm has blown through, leaving the air crystal clear and the bay as flat as glass. It is time for me to unplug my Macbook Pro and iPhone 6, pick up my various adapters, and pack up.

We arrive in Emeryville 45 minutes early. With any luck, I can squeeze in a ten mile night hike up Grizzly Peak and still get home in time to watch the season opener for Downton Abbey season five. I reach the ridge just in time to catch a spectacular pastel sunset over the Pacific Ocean. The omens are there. It is going to be another good year.

I?ll shoot you a Trade Alert whenever I see a window open on any of the trades above.

Good trading in 2015!

John Thomas
The Mad Hedge Fund Trader

 

JT at workThe Omens Are Good for 2015!

End of the Commodity Super Cycle

When the Trade Alerts quit working. I stop sending them out. That?s my trading strategy right now. It?s as simple as that.

So when I received a dozen emails this morning asking if it is time to double up on Linn Energy (LINE), I shot back ?Not yet!? There is no point until oil puts in a convincing bottom, and that may be 2015 business.

Traders have been watching in complete awe the rapid decent the price of Linn Energy, which is emerging as the most despised asset of 2014, after commodity producer Russia (RSX).

But it is becoming increasingly apparent that the collapse of prices for the many commodities is part of a much larger, longer-term macro trend.

(LINN) is doing the best impersonation of a company going chapter 11 I have ever seen, without actually going through with it. Only last Thursday, it paid out a dividend, which at today?s low, works out to a mind numbing 30% yield.

I tried calling the company, but they aren?t picking up, as they are inundated with inquires from investors. Search the Internet, and you find absolutely nothing. What you do find are the following reasons not to buy Linn Energy today:

1) Falling oil revenue is causing Venezuela to go bankrupt.
2) Large layoffs have started in the US oil industry.
3) The Houston real estate industry has gone zero bid.
4) Midwestern banks are either calling in oil patch loans, or not renewing them.
5) Hedge Funds have gone catatonic, their hands tied until new investor funds come in during the New Year.
6) Every oil storage facility in the world is now filled to the brim, including many of the largest tankers.

Let me tell you how insanely cheap (LINN) has gotten. In 2009, when the financial system was imploding and the global economy was thought to be entering a prolonged Great Depression, oil dropped to $30, and (LINN) to $7.50. Today, the US economy is booming, interest rates are scraping the bottom, employment is at an eight year high, and (LINE) hit $9.70, down $70 in six months.

Go figure.

My colleague, Mad Day Trader, Jim Parker, says this could all end on Thursday, when the front month oil futures contract expires. It could.

It isn?t just the oil that is hurting. So are the rest of the precious and semi precious metals (SLV), (PPLT), (PALL), base metals (CU), (BHP), oil (USO), and food (CORN), (WEAT), (SOYB), (DBA).

Many senior hedge fund managers are now implementing strategies assuming that the commodity super cycle, which ran like a horse with the bit between its teeth for ten years, is over, done, and kaput.

Former George Soros partner, hedge fund legend Paul Tudor Jones, has been leading the intellectual charge since last year for this concept. Many major funds have joined him.

Launching at the end of 2001, when gold, silver, copper, iron ore, and other base metals, hit bottom after a 21 year bear market, it is looking like the sector reached a multi decade peak in 2011.

Commodities have long been a leading source of profits for investors of every persuasion. During the 1970?s, when president Richard Nixon took the US off of the gold standard and inflation soared into double digits, commodities were everybody?s best friend. Then, Federal Reserve governor, Paul Volker, killed them off en masse by raising the federal funds rate up to a nosebleed 18.5%.

Commodities died a long slow and painful death. I joined Morgan Stanley about that time with the mandate to build an international equities business from scratch. In those days, the most commonly traded foreign securities were gold stocks. For years, I watched long-suffering clients buy every dip until they no longer ceased to exist.

The managing director responsible for covering the copper industry was steadily moved to ever smaller offices, first near the elevators, then the men?s room, and finally out of the building completely. He retired early when the industry consolidated into just two companies, and there was no one left to cover. It was heartbreaking to watch. Warning: we could be in for a repeat.

After two decades of downsizing, rationalization, and bankruptcies, the supply of most commodities shrank to a shadow of its former self by 2000. Then, China suddenly showed up as a voracious consumer of everything. It was off to the races, and hedge fund managers were sent scurrying to look up long forgotten ticker symbols and futures contracts.

By then commodities promoters, especially the gold bugs, had become a pretty scruffy lot. They would show up at conferences with dirt under their fingernails, wearing threadbare shirts and suits that looked like they came from the Salvation Army. As prices steadily rose, the Brioni suits started making appearances, followed by Turnbull & Asser shirts and Gucci loafers.

There was a crucial aspect of the bull case for commodities that made it particularly compelling. While you can simply create more stocks and bonds by running a printing press, or these days, creating digital entries on excel spreadsheets, that is definitely not the case with commodities. To discover deposits, raise the capital, get permits and licenses, pay the bribes, build the infrastructure, and dig the mines and pits for most commodities, takes 5-15 years.

So while demand may soar, supply comes on at a snail pace. Because these markets were so illiquid, a 1% rise in demand would easily crease price hikes of 50%, 100%, and more. That is exactly what happened. Gold soared from $250 to $1,922. This is what a hedge fund manager will tell us is the perfect asymmetric trade. Silver rocketed from $2 to $50. Copper leapt from 80 cents a pound to $4.50. Everyone instantly became commodities experts. An underweight position in the sector left most managers in the dust.

Some 14 years later and now what are we seeing? Many of the gigantic projects that started showing up on drawing boards in 2001 are coming on stream. In the meantime, slowing economic growth in China means their appetite has become less than endless.

Supply and demand fell out of balance. The infinitesimal change in demand that delivered red-hot price gains in the 2000?s is now producing equally impressive price declines. And therein lies the problem. Click here for my piece on the mothballing of brand new Australian iron ore projects, ?BHP Cuts Bode Ill for the Global Economy?.

But this time it may be different. In my discussions with the senior Chinese leadership over the years, there has been one recurring theme. They would love to have America?s service economy.

I always tell them that they have a real beef with their ancient ancestors. When they migrated out of Africa 50,000 years ago, they stopped moving the people exactly where the natural resources aren?t. If they had only continued a little farther across the Bering Straights to North America, they would be drowning in resources, as we are in the US.

By upgrading their economy from a manufacturing, to a services based economy, the Chinese will substantially change the makeup of their GDP growth. Added value will come in the form of intellectual capital, which creates patents, trademarks, copyrights, and brands. The raw material is brainpower, which China already has plenty of.

There will no longer be any need to import massive amounts of commodities from abroad. If I am right, this would explain why prices for many commodities have fallen further that a Middle Kingdom economy growing at a 7.5% annual rate would suggest. This is the heart of the argument that the commodities super cycle is over.

If so, the implications for global assets prices are huge. It is great news for equities, especially for big commod
ity importing countries like the US, Japan, and Europe. This may be why we are seeing such straight line, one way moves up in global equity markets this year.

It is very bad news for commodity exporting countries, like Australia, South America, and the Middle East. This is why a large short position in the Australian dollar is a core position in Tudor-Jones? portfolio. Take a look at the chart for Aussie against the US dollar (FXA) since 2013, and it looks like it has come down with a severe case of Montezuma?s revenge.

The Aussie could hit 80 cents, and eventually 75 cents to the greenback before the crying ends. Australians better pay for their foreign vacations fast before prices go through the roof. It also explains why the route has carried on across such a broad, seemingly unconnected range of commodities.

In the end, my friend at Morgan Stanley had the last laugh.

When the commodity super cycle began, there was almost no one around still working who knew the industry as he did. He was hired by a big hedge fund and earned a $25 million performance bonus in the first year out. And he ended up with the biggest damn office in the whole company, a corner one with a spectacular view of midtown Manhattan.

He is now retired for good, working on his short game at Pebble Beach.

Good for you, John.

 

LINE 12-15-14

TNX 12-15-14

COPPER 3-21-14

FXA 12-15-14

GOLD 3-21-14

WTIC 12-12-14

 

Gold Coins

Not as Shiny as it Once Was

The China View from 30,000 Feet

I have long sat beside the table of McKinsey & Co., the best management consulting company in Asia, hoping to catch some crumbs of wisdom (click here for their home page). So, I jumped at the chance to have breakfast with Shanghai based Worldwide Managing Director, Dominic Barton, when he passed through San Francisco visiting clients.

These are usually sedentary affairs, but Dominic spit out fascinating statistics so fast I had to write furiously to keep up. Sadly, my bacon and eggs grew cold and congealed. Asia has accounted for 50% of world GDP for most of human history. It dipped down to only 10% over the last two centuries, but is now on the way back up. That implies that China?s GDP will triple relative to our own from current levels.

A $500 billion infrastructure oriented stimulus package enabled the Middle Kingdom to recover faster from the Great Recession than the West, and if this didn?t work, they had another $500 billion package sitting on the shelf. But with GDP of only $6.5 trillion today, don?t count on China bailing out our $16.5 trillion economy.

China is trying to free itself from an overdependence on exports by creating a domestic demand driven economy. The result will be 900 million Asians joining the global middle class who are all going to want cell phones, PC?s, and to live in big cities. Asia has a huge edge over the West with a very pro-growth demographic pyramid. China needs to spend a further $2 trillion in infrastructure spending, and a new 75-story skyscraper is going up there every three hours!

Some 1,000 years ago, the Silk Road was the world?s major trade route, and today intra-Asian trade exceeds trade with the West. The commodity boom will accelerate as China withdraws supplies from the market for its own consumption, as it has already done with the rare earths.

Climate change is going to become a contentious political issue, with per capita carbon emission at 19 tons in the US, compared to only 4.6 tons in China, but with all of the new growth coming from the latter. Protectionism, pandemics, huge food and water shortages, and rising income inequality are other threats to growth.

To me, this all adds up to buying on the next substantial dip big core longs in China (FXI), commodities (DBC) and the 2X (DYY), food (DBA), and water (PHO). A quick Egg McMuffin next door filled my other needs.

Egg McMuffin

FXI 4-23-14

DBA 4-23-14

PHO 4-23-14

Great Wall of China

It?s Pedal to the Metal Once Again

If the prospect of WWIII can?t knock this market down, what will it take? A giant asteroid that destroys the earth?

I would have used ?Balls to the Wall? in the headline for this piece. But as this is a family oriented newsletter I opted for the more politically correct screamer.

Even the most hardened and seasoned traders, like me and Mad Day Trader Jim Parker, were stunned by how fast the markets bounced back from Monday?s war scares in the Ukraine. Of course, everything I said in my Monday letter came true.

It would have been nice if the recovery stretched out over a longer period of time, giving me better entry points for my Trade Alerts. But that was not to be. Too many people are still frantically trying to get in this market. There are oceans of cash everywhere earning virtually nothing. It seems the new trading strategy is that if something hasn?t gone down for three days, you buy it.

Bizarre as it may seem, the weather is emerging as the big driver of markets this year. Even the Federal Reserve is now saying that the weather was a big drag on the economy. This means that every negative data point for the next few months has a great excuse to be ignored.

It also means the growth which was lost in Q1 will get added back in during Q2 as the economy plays catch up. This has the potential to create a growth surge, possibly from a 1% annualized rate to as much as a 5% in the spring.

It is inevitable that this would trigger a major spike up in all risk assets. This realization is rippling throughout the markets to create one of those ?Aha? moments, much like we saw last October, when it became obvious that the indexes would melt up for the rest of 2013. Fasten your seat belt!

If you have any doubts about this scenario, you better take a look at the commodities markets, both hard and soft (DBA). After a dreadful three years, the chart now has the trajectory of a bat out of hell. What might cause this? How about a global synchronized economic recovery that boost US growth by a full 100 basis points or higher in 2014?

So I am going to take advantage of the pre Friday nonfarm payroll doldrums to start loading the boat with positions and scaling up risk. That?s why I picked up General Electric (GE) and Delta Airlines (DAL) today, classic cyclical names. Also on the short list are EBAY (EBAY), Gilead Sciences (GILD) for another visit to the trough, Goldman Sachs Group (GS), and QUALCOMM (QCOM).

Today?s new trades graciously turned immediately profitable, taking my performance up to yet another all time high of 134.41% since inception, and a 2014 year to date gain of 11.91%. That improves my average annualized return to a stratospheric 41.4%. Incredibly, after last year?s torrid 68% profit, my performance is getting even better. It appears that, like a fine Napa Valley wine, I improve with age.

Yes, I know you have been told by the talking heads on TV that stocks are expensive, and that a crash is imminent. Personally, I think equities are cheap and that we are on our way to a Dow Average of 100,000-200,000 by 2030 (no typo here). I will keep that view as long as the stocks that I am buying pay higher dividends than the ten-year Treasury yield (TLT), now at 2.69%.

To support my view take a look at the chart below produced by my friends at Business Insider. It shows that the share of technology names, the lead sector for the entire market, trading at more than five times sales is below 40%, a fraction of the 2000 peak.

I think we have to match, or exceed, this peak before the party is over and the lights get turned out.

GE 3-5-14

DAL 3-5-14

DBA 3-5-14

Markets Chart of the Day

Delta

A Perfect Storm Hits the Grain Trade

Grain traders have suffered a terrible 2013, a perfect storm of great news for farmers and terrible news for prices. But while farmers can make up for low prices with higher production, no such convenience exists for grain traders.

In January, right out of the gate, the USDA predicted that the US would produce the largest corn crop in history, or some 96 million bushels. That would be the largest since 1936. It now appears that this could be a low-ball figure.

Some private estimated see the total reaching 100 million bushels before the crying is over. Some 63% of the corn crop is now rated good/excellent, well above the five-year average of 58%, and trending northward.

Geopolitics has also conspired to drive prices southward. Egypt, with its burgeoning 83 million population, with a single river (the Nile) and a bleak desert to support it, is far and away the world?s largest wheat importer. A recent coup d??tat on the heels on an economic collapse promises to remove it from the marketplace soon. Buyers without cash are not buyers at all, no matter how dire the need. Only food aid from the US government or the United Nations can step in at this stage to head off mass starvation.

As if the news were not bad enough, the Russian cartel that controls two thirds of the world?s $22 billion a year potash supply, a crucial fertilizer used globally, collapsed last week over a price dispute. Known to chemists like me as Potassium carbonate, potassium sulfate, or potassium chloride, this compound is a key factor in strengthening roots during the growing cycle. One analyst said that the breakup of the cartel is akin to ?Saudi Arabia dropping out of OPEC.?

The move promises to take potash prices down from the 2008 peak of $1,000/tonne to $300 by yearend. Potash stocks crashed worldwide, with lead firm Potash (OT) diving 30%. Agrium (AGU) was down by 15%.

This will enable farmers to buy more fertilizer at cheaper prices next year, driving down the prices on far month futures contracts today. Too bad the Canadian government didn?t allow the sale of Potash (POT) to China go through on national security grounds. The shareholders must be kicking themselves.

The move promises to demolish the entire grade trade for this year. Not only has the Potash industry been hurt, so have agricultural equipment manufacturers, like Deere (DE) and Caterpillar (CAT) and the Powershares Multisector Agricultural Commodity Fund ETF (DBA).

Long gone are the heady days of last year, when scorching temperatures induced by global warming caused grain prices to nearly double. Some nine out of the ten last years have been the hottest in recorded history. Global warming denier-in-chief, Texas governor Rick Perry, saw his state suffer 100 consecutive days of over 100 degree temperature.

For me, these developments put the grain trade off limits for the foreseeable future. The only kind thing to be said here is that this will eventually lead to a final bottom that we can eventually trade off of. That would set up a killer position for the nimble if hot weather returns in 2014.

POT 8-2-13

AGU 8-2-13

CORN 8-2-13

DBA 8-2-13

CAT 8-2-13

Potash Crystals Potash Crystals

Mob Scene I Don?t See Any Grain Buyers Here

An Environmental Activist?s Take on the Markets

I spent an evening with Lester Brown, president of the Earth Policy Institute and a winner of the coveted MacArthur Prize, for some long-term thinking about the environment and its investment implications.

Global warming is causing the melting of ice sheets in Greenland and Antarctica, glaciers in the Himalayas, and the Sierra snowpack. Water tables are falling and fossil aquifers are depleting. In the coming decades this will cause severe shortages of fresh water that could lead to crop failures in India and China, where one billion people depend on mountain runoff to irrigate crops, and even California, which delivers 80% of America?s vegetables.

The fresh water inputs in one person?s food and materials consumption works out to some 2,000 liters a day. That is no typo. As a result, all food prices will rise. To head off the greatest threat to the global food supply in human history, we need to cut carbon emissions by 80% before 2020, not 2050, as is being discussed in Copenhagen.

This can only be accomplished by redefining food and the environment as national security issue and launching a wartime mobilization. These difficult goals are achievable. Enough sunlight hits the earth in a day to power the global economy for a year. Texas alone has more than 20 gigawatts of wind power operating, under construction, or planned, enough to take 5% of our 250 coal fired power plants offline. Electricity demand could be cut by 90% purely through greater efficiencies, like switching from incandescent bulbs to LED?s.

Europe could get its entire 300 gigawatt power supply from solar plants in North Africa at current market prices. Cars powered by wind generated electricity would bring fuel costs down to an equivalent 75 cents a gallon, as electric motors are three times more efficient than internal combustion engines.

While Brown?s predictions are a little extreme for many, they mesh perfectly with my long term bullish cases for food and water plays. Take another look at the food sector ETF?s, (DBA) and (MOO), and the water space ETF?s (PHO) and (FIW).

DBA 6-14-13

MOO 6-14-13

PHO 6-14-13

Water Fall

The China View from 30,000 Feet

I have long sat beside the table of McKinsey & Co., the best management consulting company in Asia, hoping to catch some crumbs of wisdom. So, I jumped at the chance to have breakfast with Shanghai based Worldwide Managing Director, Dominic Barton, when he passed through San Francisco visiting clients.

These are usually sedentary affairs, but Dominic spit out fascinating statistics so fast I had to write furiously to keep up. Sadly, my bacon and eggs grew cold and congealed. Asia has accounted for 50% of world GDP for most of human history. It dipped down to only 10% over the last two centuries, but is now on the way back up. That implies that China?s GDP will triple relative to our own from current levels.

A $500 billion infrastructure oriented stimulus package enabled the Middle Kingdom to recover faster from the Great Recession than the West, and if this didn?t work, they had another $500 billion package sitting on the shelf. But with GDP of only $5.5 trillion today, don?t count on China bailing out our $15.5 trillion economy.

China is trying to free itself from an overdependence on exports by creating a domestic demand driven economy. The result will be 900 million Asians joining the global middle class who are all going to want cell phones, PC?s, and to live in big cities. Asia has a huge edge over the West with a very pro-growth demographic pyramid. China needs to spend a further $2 trillion in infrastructure spending, and a new 75-story skyscraper is going up there every three hours!

Some 1,000 years ago, the Silk Road was the world?s major trade route, and today intra-Asian trade exceeds trade with the West. The commodity boom will accelerate as China withdraws supplies from the market for its own consumption, as it has already done with the rare earths.

Climate change is going to become a contentious political issue, with per capita carbon emission at 19 tons in the US, compared to only 4.6 tons in China, but with all of the new growth coming from the later. Protectionism, pandemics, huge food and water shortages, and rising income inequality are other threats to growth.

To me, this all adds up to buying on the next substantial dip big core longs in China (FXI), commodities (DBC) and the 2X (DYY), food (DBA), and water (PHO). A quick Egg McMuffin next door filled my other needs.

FXI 6-12-13

DBA 6-12-13

PHO 6-12-13

Great Wall of China

The Bottom is in for the Ags

Take a look at the drought monitor below, and you?ll see that it looks exactly like the one we saw a year ago. Yes, that?s the one right before we saw prices double for corn (CORN) and most other agricultural products.

The global warming trade may be about to return with a vengeance. If the weather so far this year is any indication, the trading pits in Chicago could break out in riots at any time. This winter, hurricane Sandy ravaged the east coast, tornadoes decimated Kansas, and California suffered its driest winter in 20 years. Water rationing on the west coast is now almost a certainty. Extreme weather is breaking out everywhere.

Regular readers are well aware of my predictions of major global food shortages in the years ahead (click here for ?Is Food the New Distressed Asset??).

The basic problem is that the world is making people faster than the food to feed them. Rising emerging market standards of living are increasing their food consumption at the expense of poorer countries.? If everyone in China eats one extra egg a day, the entire continent of Africa has to starve.

The global population is expected to rise from 7 billion to 9 billion over the next 40 years, and half of that increase will occur in countries that can?t feed themselves today, largely in the Middle East.

Global fresh water supplies are shrinking fast. Throw global warming into the mix, and a crisis will unfold sooner than later. These are all arguments to use a major dips in the food ETF?s, (CORN), (SOYB), (DBA), and (WEAT), to pick up long positions. And we have just witnessed a nine month long sell off in the sector. In addition, my technical trading pro, Jim Parker, The Mad Day Trader, loves the charts. It?s time to go shopping in the cereal section of your local stock exchange.

US Drought Monitor

CORN 5-29-13

CORN a 5-29-13

CN13 5-29-13

Popcorn Time to Go Long Corn

The Corn Crash Continues

Pit traders of the ags are bruised, battered, and broken, in the wake of Thursday?s US Department of Agriculture crop report showing that there is a whole lot more food out there than anyone imagined possible.

Corn was the real shocker. It has long been a nostrum in the ag markets that high prices cure high prices, and that is exactly what is happening now. In the wake of last summer?s spectacular drought induced shortages, which saw corn prices nearly double, farmers rushed to expanding plantings in 2013. The government expects that some 97.3 million acres will be sown this year, the most since the Dust Bowl days of 1936.

The government agency boosted estimates of stockpiles nearly 10%, from 5 to 5.4 billion bushels. Demand from ethanol makers has collapsed as they have priced themselves out of the market, leading to the closure of nearly 10% of the country?s fermenting facilities. Purchases by ranchers as feedstuff for cattle have been weak. These are enormous upward revisions. Prices took a 10%, limit move down on Friday, and are taking another dive today.

Even though the numbers were not as dramatic for the other grains, their prices suffered as well. Some of the new corn is being grown at the expense of soybeans, which saw a small decline in plantings. But prices took a dump anyway. Wheat (WEAT) has amazingly dropped below the summer, 2012 lows. The ag ETF (DBA), which includes the machinery and fertilizer companies, has performed the worst of all, and is threatening a new three year low. Virtually the entire 2012 ag bubble has been given back.

The long term bull case for food could not be more compelling (click here for ?Is Food the New Distressed Asset??). The world is producing people faster than the food to feed them. The global population is expected to rise from 7 to 9 billion by 2050. Half of that increase will happen in countries that are unable to feed themselves, like the Middle East.

Food consumption in the US isn?t dropping anytime soon. According to Yahoo data, ?Plus sized swimsuits? searches were up 530% in March.

There is also a huge emerging market play here. Rising standards of living mean better diets. Better food requires more calories and water to grow. To raise one pound of beef, you need 2,200 gallons of fresh water. It is true that if everyone in China eats one extra egg a day, the entire continent of Africa has to starve.

I have been ignoring the ags since last summer, when, if you didn?t get in during the first week, you missed the entire drought play. Since then I dipped in on the short side in corn, playing the slow unwinding of the price bubble.

With this collapse, the long side is now, at last, back on the table. Let the current selloff shake itself out. Then, take a look at some long plays in case the global warming trade returns this summer. Nine of the ten past years have been the hottest in history. Why should this year be any different? If Texas governor, Rick Perry, says something isn?t happening with the environment, you can pretty much count that it is.

If you have any doubts, take a look at the latest drought monitor map below, which shows long-term arid conditions persisting in most of the Midwest.

CORN 4-1-13

WEAT 4-1-13

DBA 4-1-13

US Drought Monitor