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It?s Safe to Sell Short the Yen Again

I think we are at the tag end of the recent unbelievable bout of yen strength.

Triggered by the Bank of Japan?s shocking move to negative interest rates (NIRP), it has been driven by a massive unwind of hedge fund positions in everything around the world that were all financed by short yen positions.

The memo is out now, and the bulk of the ?hot money? positions are gone. After some fits and starts, I expect the yen to resume its long-term structural downtrend shortly.

If for any reasons you can?t do options, just buy the ProShares Ultra Short Yen ETF (YCS) outright. This is the best entry point in a year.

?Oh, how I despise the yen, let me count the ways.?

I?m sure Shakespeare would have come up with a line of iambic pentameter similar to this if he were a foreign exchange trader. I firmly believe that a short position in the yen should be at the core of any hedged portfolio for the next decade.

To remind you why you hate the currency of the land of the rising sun, I?ll refresh your memory with this short list:

1) With the world?s structurally weakest major economy, Japan is certain to be the last country to raise interest rates. Interest rate differentials between countries are the single greatest driver of foreign exchange rates. That means the yen is taking the downtown express.

2) This is inciting big hedge funds to borrow yen and sell it to finance longs in every other corner of the financial markets. So ?RISK ON? means more yen selling, a lot.

3) Japan has the world?s worst demographic outlook that assures its problems will only get worse. They?re just not making enough Japanese any more. Countries that are not minting new consumers in large numbers tend to have poor economies and weak currencies.

4) The sovereign debt crisis in Europe is prompting investors to scan the horizon for the next troubled country. With gross debt well over a nosebleed 270% of GDP, or 160% when you net out inter agency cross holdings, Japan is at the top of the list.

5) The Japanese ten-year bond market, with a yield AT AN ABSOLUTELY EYE-POPPING -0.08%, is a disaster waiting to happen. It makes US Treasury bonds look generous by comparison at 1.70%. No yield support here whatsoever.

6) You have two willing co-conspirators in this trade, the Ministry of Finance and the Bank of Japan, who will move Mount Fuji if they must to get the yen down and bail out the country?s beleaguered exporters and revive the economy.

When the big turn inevitably comes, we?re going from the current ?112.75 to ?125, then ?130, then ?150. That works out to a price of $150 for the (YCS), which last traded at $76.88. But it might take a few years to get there.

If you think this is extreme, let me remind you that when I first went to Japan in the early seventies, the yen was trading at ?305, and had just been revalued from the Peace Treaty Dodge line rate of ?360.

To me the ?112.75 I see on my screen today is unbelievably expensive.

fxy

YCS 2-25-16

Japanese Girl

Its All Over for the Yen

The Great American Rot is Ending

Those of a certain age can?t help but remember that things for the US went to hell in a hand basket after 1963.

That?s when President John F. Kennedy was assassinated, heralding decades of turmoil. Race riots exploded everywhere. The Vietnam War ramped up out of control, taking 60,000 lives, and destroying the nation?s finances. Nixon took the US off the gold standard.

When people complain about our challenges now, I laugh to my self and think this is nothing compared to that unfortunate decade.

Two oil shocks and hyper inflation followed. We reached a low point when Revolutionary Guards seized American hostages in Tehran in 1979.

We received a respite after 1982 with the rollback of a century?s worth of regulation during the Reagan years. But a borrowing binge sent the national debt soaring, from $1 trillion to $18 trillion. An 18-year bull market in stocks ensued. The United States share of global GDP continued to fade.

Basking in the decisive victories of WWII, the Greatest Generation saw their country account for 50% of global GDP, the largest in history, except, perhaps, for the Roman Empire. After that, our share of global business activity began a long steady decline. Today, we are hovering around 22%.

Hitch hiking around Europe in 1968 and 1969 with a backpack and a dog-eared copy of Europe on $5 a Day, I traded in a dollar for five French francs, four Deutschmarks, three Swiss francs, and 0.40 British pounds.

When I first landed in Japan in 1974, there were Y305 yen to the dollar. Even after a strong year, the greenback is still down by 75% against these currencies, except for sterling. How things have changed.

We now live in a world where the US suddenly has the strongest economy, currency and stock market in the world. Are these leading indicators of better things to come?

Is the Great American Rot finally ending? Is everything that has gone wrong with the United States over the past half century reversing?

The national finances are hinting as much. Over the last four years, the federal budget deficit has been shrinking at the fastest rate in history, from $1.4 trillion to only $483 million.

If the economy continues to grow at its present modest 2.5% rate, we should be in balance by 2018. Then the national debt, which will peak at around $18 trillion, will start to shrink for the first time in 20 years.

And since chronic deflation has crashed borrowing costs precipitously, the cost of maintaining this debt has dramatically declined.

A country with high economic growth, no inflation, generationally low energy costs, a strong currency, overwhelming technology superiority, a strong military and political stability is always a fantastic investment opportunity.

It certainly is compared to the highly deflationary, weak currency, technologically lagging major economies abroad.

You spend a lifetime looking for these as a researcher, and only come up with a handful. Perhaps this is what financial markets have been trying to tell us all along.

It certainly is what foreign investors have been telling us for years, who have been moving capital into the US as fast as they can (click here for ?The New Offshore Center: America?).

It gets even better. These ideal conditions are only the lead up to my roaring twenties scenario (click here for ?Get Ready for the Coming Golden Age?), when over saving, under consuming baby boomers enter a mass extinction, and a gale force demographic headwind veers to a tailwind.

That opens the way for the country to return to a consistent 4% GDP growth, with modest inflation and higher interest rates.

Which leads us all to the great screaming question of the moment: Why is the US stock market trading so poorly this year? If the long term prospects for companies are so great, why have shares suddenly started performing feebly?

Not only has it gone nowhere for three months, market volatility has doubled, making life for all of us dull, mean and brutish.

There are a few short-term answers to this conundrum.

There is no doubt that the Euro and the yen have fallen so sharply against the greenback that it is hurting the earnings of multinationals when translated back to dollars.

This has cut S&P 500 earnings forecasts for the year. And these days, everyone is a multinational, including the Diary of a Mad Hedge Fund Trader, where one third of our subscribers live abroad.

Another short-term factor is the complete collapse of the price of oil. Again, it happened so fast, and was so unexpected, that it too is having a sudden deleterious influence of broader S&P earnings.

Go no further than oil giant Chevron, which just announced a big drop in earnings and a massive cut in its capital spending budget for 2016.

The final nail in the Q4 coffin has been bank earnings, which all took big hits in trading revenues. Virtually all were taken short by the huge, one-way rally in bond prices in recent months and the collapse of interest rates.

This happens when panicky customers come in and lift the banks? inventories, and trading desks have to spend the rest of the day, week and month trying to get them back at a loss.

I have seen this happen too many times. This is why the industry always trades at such low multiples.

With no leadership from the biggest sectors of the market, financials and energy, and with the horsemen of technology and biotech vastly overbought, it doesn?t leave the nimble stock picker with too many choices.

The end result is a stock market that goes nowhere, but with a lot of volatility. Sound familiar?

Fortunately, there is a happy ending to this story. Eventually, all of the short-term factors will disappear. Oil prices and bond yields will go back up. The dollar will moderate. Corporate earnings growth will return to the 10% neighborhood. And stocks will reach new highs.

But it could take a while to digest all of this. This is a lot of red meat to take in all at one time. If the market grinds sideways in a 15% range all year, and then breaks out to the upside once again for a 5% annual gain, most investors would consider this a win.

Once again, index investors will beat the pants off of hedge fund managers, as they have for the past seven years.

In the meantime, I doubt the stock indexes will drop more than 6% % from here, with the (SPY) at $189, and we have already seen a 6% hair cut from last year?s peak.?

Knock a tenth off a 16.5 X forward earnings multiple with zero inflation, cheap energy, ultra low interest rates and hyper accelerating technology, and all of a sudden, stocks look pretty cheap again.

As the super sleuth, Sherlock Homes used to say, ?When you have eliminated the impossible, whatever remains, however improbable, must be the truth?.

SPY 2-5-16

TLT 2-5-16

USO 2-5-1
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GOLD 2-65-16

FXE 2-5-16

Holmes & WatsonIt?s All Elementary

Bank of Japan Bombshell Boosts Markets

I was just about to don my backpack and head out for my evening hike when I caught a phone call from Tokyo.

The Bank of Japan had just announced they were implementing negative interest rates for the first time in history. The Japanese yen (FXE), (YCS) was in free fall and the stock market (DXJ) was soaring.

Note to self: don?t ever answer the phone just as I?m heading out the door. Good-bye hike, hello another inch on my waistline.

However, bank stocks were getting destroyed, as they would now have to pay money to the central bank to accept deposits, as they already do in Europe and Switzerland.

The overnight trading in S&P 500 (SPY) futures jumped from unchanged to up 100 points. It looked like January was going to go out with a bang. This could be the mother of all month end window dressings.

It really was a day for moves that made no sense. Bonds (TLT) rose with stocks on the hopes that any Fed interest rate hikes for this year will be cancelled. That?s like dogs and cats laying together.

Gold (GLD) rose modestly, even though the prospect of more quantitative easing anywhere in the world should have caused it to crater.

The US dollar was robust (UUP), just when you?d think that lower for longer interest rates should weaken it. I guess it?s a case of being the best house in a bad neighborhood.

Oil (USO), the main driver of all process for the past six months, was strangely unchanged for a change.

It was really one of those days when you wanted to hurl your empty beer cans at the TV, throw up your hands, and cry.

Personally, I don?t think US risk markets are out of the woods yet. We can?t escape the reality that earning multiples for American companies are falling.

You have to ask the question of what do negative interest rates really mean for the global economy? Hint: none of the answers are good.

Blame it on a Fed tightening cycle, which has just been shifted from second gear back to first. Blame it on a decade long GDP growth rate, which is stuck at 2%. That is caused by demographic headwinds that we can do nothing about.

Whatever the reason, stocks are not headed straight up from here. I think we are just squeezing out the shorts for the umpteenth time. They could all be cleaned out by the time the (SPY) hits $195.

Then it will be back to the low end of our new, violent range, probably just above $182.

DXJ 1-29-16

FXY 1-29-16

YCS 1-29-16

Bank of JapanSurprise!

2016 Annual Asset Class Review

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 panoramic 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.

I am not Houdini, so I go downstairs to use the larger public showers.

Zephyr

We are now pulling away from Chicago?s Union Station, leaving its hurried commuters, buskers, panhandlers, and majestic great halls behind. I love this building as a monument to American accomplishment.

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 country 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 6.

After making the rounds with strategists, portfolio managers, and hedge fund traders, I can confirm that 2015 was one of the toughest to trade for careers lasting 30, 40, or 50 years. Even the stay-at-home index players had their heads handed to them.

With the Dow gaining 3.1% in 2015, and S&P 500 almost dead unchanged, this was a year of endless frustration. Volatility fell to the floor, staying at a monotonous 12% for eight boring consecutive months before spiking repeatedly many times to as high as 52%. Most hedge funds lagged the index by miles.

My Trade Alert Service, hauled in an astounding 38.8% profit, at the high was up 48.7%, and has become the talk of the hedge fund industry.

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 Four Key Variables for 2016

1) Will the Fed raise interest rates more or not?
2) Will China?s emerging economy see a hard or soft landing?
3) Will Japanese and European quantitative easing increase, or remain the same?
4) Will oil bottom and stay low, or bounce hard?

Here are your answers to the above: no, soft, more later, bounce hard later.

There you go! That?s all the research you have to do for the coming year. Everything else is a piece of cake.

The Ten Highlights of 2015

1) Stocks will finish higher in 2016, almost certainly more than the previous year, somewhere in the 5% range and 7% with dividends. Cheap energy, a recovering global economy, and 2-3% GDP growth, will be the drivers. However, this year we have a headwind of rising interest rates and falling multiples.

2) Expect stocks to take a 15% dive. That gives us a -15% to +5% trading range for the year. Volatility will remain permanently higher, with several large spikes up. That means you are going to have to pedal harder to earn your crust of bread in 2016.

3) The Treasury bond market will modestly grind down, anticipating the next 25 basis point rate rise from the Federal Reserve, and then the next one after that.

4) The yen will lose another 5% against the dollar.

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

6) Oil stays in a $30-$60 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 $250. (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 for years.

10) The 2016 presidential election will eat up immense amounts of media and research time, but will have absolutely no impact on financial markets. Give your money to charity instead.windmills

The Thumbnail Portfolio

Equities - Long. A rising but high volatility year takes the S&P 500 up to 2,200. Technology, biotech, energy, solar, consumer discretionary, and financials lead. Energy should find its bottom, but later than sooner.

Bonds - Short. Down for the entire year, but not by much, with long periods of stagnation.

Foreign Currencies - Short. The US dollar maintains its bull trend, especially against the Yen and the Euro, but won't gain nearly as much as in 2015.

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

Precious Metals - Buy as close to $1,000 as you can. We are overdue for a trading rally.

Agriculture - Long. El Nino in the north and droughts in Latin American should add up to higher prices.

Real estate - Long. Multifamily up, commercial up, single family homes up small.

farmland

1) The Economy - Fortress America

I think real US economic growth will come in at the 2.5%-3% range.

With a generational demographic drag continuing for five more years, don?t expect more than that. Big spenders, those in the 46-50 age group, don?t return in larger numbers until 2022.

But this negative will be offset by a plethora of positives, like hyper-accelerating technology, global expansion, and the lingering effects of the Fed?s massive five year quantitative easing.

US corporate profits will keep pushing to new all time highs. But this year we won?t be held back by the collapsing economies of Europe, China, and Japan, which subtracted about 0.5% from American economic growth, nor weak energy.

US 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 six years, we have seen the most dramatic increase in earnings in history, taking them to all-time highs.

Technology and dramatically lower energy costs are the principal sources of profit 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 2015? Most of that is getting plowed right back into new start ups, increasing the rate of technology improvements even further, and the productivity gains that come with it.

We no longer have the free lunch of zero interest rates. But the cost of money will rise so slowly that it will barely impact profits. Deflation is here to stay. Watch the headline jobless rate fall below 5% to a full employment economy.

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.

Moose on Snowy MountainA Rocky Mountain Moose Family

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

For the first time in seven years, earnings multiples are going to fall, but not by much. That is the only possible outcome in a world with rising interest rates, however modestly.

If multiples fall by 5%, from the current 18X to 17.1X, profits increase by 10%, and you throw in a 2% dividend, you should net out a 7% return by the end of the year.

S&P 500 earnings fell by 6% in 2015, but take out oil and they grew by 5.6%. In 2016, energy will be a lesser drag, or not at all. That makes my 10% target doable.

That is not much of a return with which to take on a lot of risk. But remember, in a near zero interest rate world, there is nothing else to buy.

This is not an outrageous expectation, given the 10-22 earnings multiple range that we have enjoyed during the last 30 years.

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. Yet, that is years off.

After all, my friend, Janet Yellen, is paying you to buy stock with cheap money, so why not? Borrowing money at close to zero and investing in 2% dividend paying stocks has become the world?s largest carry trade.

Rising interest rates will have one additional worrying impact on stock prices. They will pare back mergers and acquisitions and corporate buy backs in 2016.

Together these were the sources of all new net buying of stocks in 2015, some $5.5 trillion worth. Call it financial engineering, but the market loves it.

Although energy looks terrible now, it could well be the top-performing sector by the end of the year, to be followed by commodities.

Certainly, every hedge fund and activist investor out there is undergoing a crash course on oil fundamentals. After a 13-year expansion of leverage in the industry, it is ripe for a cleanout.

Solar stocks will continue on a tear, now that the 30% federal investment tax subsidy has been extended by five more years. Look at Solar City (SCTY), First Solar (FSLR), 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.

Share prices will deliver anything but a straight-line move. Expect a couple more 10% plus corrections in 2015, and for the Volatility Index (VIX) to revisit $30 multiple times. The higher prices rise, the more common these will become.

SPX 12-31-15

QQQ 12-31-15

IWM 12-31-15

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 for breakfast, lunch, and dinner.

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.

I have to confess that I am leaning towards the ?one and done? school of thought with regards to the Fed?s interest rate policy. We may see a second 25 basis point rise in June, but only if the economy takes off like a rocket and international concerns disappear, an unlikely probability.

If you told me that US GDP growth was 2.5%, unemployment was at a ten year low at 5.0%, and energy prices had just plunged by 68%, I would have pegged the ten-year Treasury bond yield at 6.0%. Yet here we are at 2.25%.

We clearly are seeing a brave new world.

Global QE added to a US profit glut has created more money than the fixed income markets can absorb.

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.

Fixed income turned out to be a winner for me in 2015, as I sold short every bond price spike from the summer onward. It worked like a charm.

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 62 basis points, and Japanese bonds paying a paltry 26 basis points, US Treasuries are looking like a steal.

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 a decade down the road.

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% handle on the 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, at lest for the near term.

So what will 2016 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.

We could ratchet back up to a 3% yield, but not much higher than that. This would enable the inverse Treasury bond bear ETF (TBT) to reverse its dismal 2015 performance, taking it from $46 back up to $60.

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 suddenly went out of fashion for many investors, which is typical at market tops. As a result, junk bonds (JNK) and (HYG), REITS (HCP), and master limited partnerships (AMLP) are showing their first value in five years.

There is also emerging market sovereign debt to consider (PCY). If oil and commodities finally bottom, these high yielding bonds should take off on a tear.

This asset class was hammered last year, so we are now facing a rare entry point.

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.

The collapse of the junk bond market suddenly made credit quality a big deal last year. What is better than lending to the government, unless you happen to live in Puerto Rico or Illinois.

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.

One question I always get asked at lunches, conferences, and lectures is what is going to happen to the budget deficit?

The short answer is that it disappears in 2018 with no change in current law, thanks to steady growth in tax revenues and no big new wars.

And Social Security? It will be fully funded by 2030, thanks to a huge demographic tailwind provided by the addition of 86 million Millennials to the tax rolls.

A bump up in US GDP growth from 2% to 4% during the 2020?s will also be a huge help, again, provided we don?t start any more wars.

It looks like I am going to be able to collect after all.

TLT 12-31-15

TBT 12-31-15

MennonitesA Visit to the 19th Century

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

Without much movement in interest rates in 2016, you can expect the same for foreign currencies.

Last year, we saw never ending expectations of aggressive quantitative easing by foreign central banks, which never really showed. What we did get, was always disappointing.

The decade long bull market in the greenback continues, but not by much. You can forget about those dramatic double digit gains the dollar made against the Euro at the beginning of last year, which we absolutely nailed.

The fundamental play for the Japanese yen is still from the short side. But don?t expect movement until we see another new leg of quantitative easing from the Bank of Japan. It could be a long wait.

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 ?130 to the dollar sometime in 2016, and ?150 further down the road.

I have many friends in Japan looking for an 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 continue raising rates the fastest.

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.

For a sleeper, use the next plunge in emerging markets to buy the Chinese Yuan ETF (CYB) for your back book. Now that the Yuan is an IMF reserve currency, it has attained new respectability.

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.

FXE 12-31-15

FXY 12-31-15

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 2015, the preeminent investment disaster of the year. Those who did are now looking for jobs on Craig?s List.

It was another year of overwhelming supply meeting flagging demand, both in Europe and Asia. Blame China, the one 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 $3.5 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. This trend ran head on into a decade long expansion of capacity by the industry.

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 2015, 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.

Not even the arrival of one of the biggest El Nino events in history could bail them out.

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 soybean (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 12-31-15

DBA 12-31-15

PHO 12-31-15

JT snow angelSnow Angel on the Continental Divide

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

You are now an oil trader, even if you didn?t realize it. Yikes!

The short-term direction of the price of Texas tea will be the principal driver for the prices of all asset classes, as it was for the 2015.

The smartest thing I did in 2015 was to ignore the professional traders, who called the bottom in oil monthly, based on key technical levels.

Instead, I hung on every word uttered by my old drilling buddies in the Barnett Shale, who only saw endless supply.

Guess whom I?ll be paying attention to this year?

I expect oil to bottom in 2016, and then launch a ferocious short covering rally. But when and where is anyone?s guess.

If energy legends John Hamm, John Arnold, and T. Boone Pickens have no idea where the absolute low will be, who am I to second-guess them?

When that happens, a trillion dollars will pour out of the sidelines into this troubled sector. Energy shares should be top-performers in 2016.

That makes energy Master Limited Partnerships, now yielding 10%-15%, especially interesting in this low yield world. Since no one in the industry knows which issuers are going bankrupt, you have to take a basket approach and buy all of them.

The Alerian MLP ETF (AMLP) does this for you in an ETF format (click here for details). At its low this fund was down by 41% this year. The last printed annualized yield I saw was 10%. That kind of return will cover up a lot of sins.

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 Buffet tap dances to work every day, as he owns the railroad.

Who knew that a new, younger Saudi king would ramp up production to once unimaginable levels and crush prices, turning the energy world upside down?

They aren?t targeting American frackers, who at 1 million barrels a day in a 92 million barrel a day demand world barely move the needle. Their goal is to destroy the economies of enemies Iran, Yemen, Russia, and of course ISIS, which need high prices to stay in business.

So far, so good.

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.

At current prices, the energy savings works out to an eye popping $550 per American driver per year!

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. The nuclear deal with Iran promises to add 500,000 to 1 million barrels a day to an already glutted global market. Iraq is ramping up production as well.

We are also seeing relentless improvements on the energy conservation front with more electric vehicles, high mileage conventional cars, and newly efficient building. Anyone of these inputs is miniscule on its own. But add them all together and you have a game changer.

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.

As is always the case, the cure for low prices is low prices. But we may never see $100/barrel crude again.

Add to your long term portfolio (DIG), Exxon Mobil (XOM), 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 2016, but expect to endure some pain first, nor to get much sleep at night.

WTIC 12-31-15

NATGAS 12-31-15

AMLP 12-31-15

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 19th century gold mines and the broken down wooden trestles leading to them, relics of previous precious metals busts. 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 $1,040 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. Gold is not dead; it is just resting.

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. China and India emerged as major buyers of gold in the final quarter of 2015.

They were joined by Russia, which was looking for non-dollar investments to dodge US economic and banking sanctions.

For me, that pegs the range for 2016 at $1,000-$1,250. 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 18 million units a year and climbing, up from a 9 million low in 2009, any inventory problems will easily get sorted out.

GOLD 12-31-15

SILVER 12-31-15

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 5 years into a 17-year run at the next peak in 2028.

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.

While the sales figures have recently been weak, it is a shortage of supply that is the cause. You can?t sell what you don?t have, at least in the real estate business.

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 for the next 20 years: there are 80 million baby boomers, 65 million Generation Xer?s who follow them, and 86 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. That's what caused the financial crisis.

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

There is a happy ending to this story. Millennials, now aged 21-37 are already starting to kick in as the dominant buyers in the market. They are just starting to transition from 30% to 70% of all new buyers in this market. The Great Millennial Migration to the suburbs has begun.

As a result, the price of single family homes should rocket tenfold during the 2020?s, as they did during the 1970?s and the 1990?s, when similar demographic influences were at play.

This will happen in the context of a coming labor shortfall and rising standards of living. Inflation returns.

Rising rents are accelerating this trend. Renters now pay 35% of the gross income, compared to only 18% for owners, and less when multiple deductions and tax subsidies are taken into account.

Remember too, that by then, the US will not have built any new houses in large numbers in 10 years. We are still operating at only a quarter of the peak rate. Thanks to the Great Recession, the construction of five million new homes has gone missing in action.

That makes a home purchase now particularly attractive for the long term, to live in, and not to speculate with.

You will boast to your grandchildren how little you paid for your house, as my grandparents once did to me ($18,000 for a four bedroom brownstone in Brooklyn in 1922).

Quite honestly, of all the asset classes mentioned in this report, purchasing your abode is probably the single best investment you can make now.

If you borrow at a 3% 5/1 ARM rate, and the long-term inflation rate is 3%, then over time you will get your house for free.

How hard is that to figure out?

Case Shiller

ITB 12-31-15

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.

After that, it was over legendary Donner Pass, and then all downhill from the Sierras, across the Central Valley, and into the Sacramento River Delta.

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 opener for Downton Abbey's final season.

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 2016!

John Thomas
The Mad Hedge Fund Trader

JT at workThe Omens Are Good for 2016!

Bring Back QE!

You wanted clarity in understanding the current state of play in the global financial markets? Here?s your #$%&*#!! clarity.

You should expect nothing less for this ridiculously expensive service of mine.

But maybe that is the cabin fever talking, now that I have been cooped up in my Tahoe lakefront estate for a week, engaging in deep research and grinding out the Trade Alerts, devoid of any human contact whatsoever.

Or, maybe it?s the high altitude.

I did have one visitor.

A black bear broke into my trash cans last light and spread garbage all over the back yard. He then left his calling card, a giant poop, in my parking space.

Judging by the size of the turds, I would say he was at least 600 pounds. This is why you never take out the trash at night in the High Sierras.

Ah, the delights of Mother Nature!

We certainly live in a confusing, topsy-turvy, tear your hair out world this year. Good news is bad news, bad news worse, and no news the worst of all.

The biggest under performing week of the year for stocks is then followed by the best. Net net, we are absolutely at a zero movement, and lots of clients complaining about poor returns on their investment.

I tallied the year-on-year performance of every major assets class and this is what I found.

+16% - Hedged Japanese Stocks (DXJ)
+15% - Hedged European stocks (HEDJ)
+13% - US dollar basket (UUP)
+10% - My house
0% - Stocks (SPY)
0% -? bonds (TLT)
-5% - Japanese Yen (FXY)
-11% - Euro (FXE)
-12% - Gold (GLD)
-18% -? Oil (USO)
-27% -? Commodities (CU)
-27% - Natural Gas (UNG)

There are some sobering conclusions to be drawn from these numbers.

There were very few opportunities to make money this year. If you were short energy, commodities, and foreign currencies, you did very well.

Followers of the Mad hedge Fund Trader can?t help but know and love these ticker symbols. They?ll notice that our long plays were found among the asset classes with the best performance, while our short bets populated the losers.

The problem with that is most financial advisors are not permitted to place client funds in the sort of inverse or leveraged ETF?s that most benefit from these kinds of moves (like the (YCS), (EUO), and (DUG)).

That left them reading about the success of others in the newspapers, even when they knew these trends were unfolding (through reading this letter).

How frustrating is that?

What was one of my best investments of 2015?

My San Francisco home, which has the additional benefit in that I get to live in it, have a place to stash all my junk, and claim big tax deductions (depreciated home office space, business use of phone, blah, blah, blah).

Of course, I do have the advantage of living in the middle of one of the greatest technology and IPO booms of all time. Every time one of these ?sharing? companies goes public, the value of my home rises by a few hundred grand.

The real problem here is that investing since the end of the Federal Reserve?s quantitative easing program ended a year ago has become a real uphill battle.

While the government was adding $3.9 trillion in funds to the economy we traders enjoyed one of the greatest free lunches of all time. It made us all look like freakin? geniuses!

Just maintaining their present $3.9 trillion balance sheet, not adding to it, has left almost every asset class dead in the water.

Heaven help us if they ever try to unwind some of that debt!

Janet has promised me that she isn?t going to engage in such monetary suicide.

The Fed is continuing with Ben Bernanke?s plan to run all of their Treasury bond holdings into expiration, even if it takes a decade to achieve this. And with deflation accelerating (see charts below), the need for such a desperate action is remote.

Still, one has to ponder the potential implications.

It all kind of makes my own 43% Trade Alert gain in 2015 look pretty good. But I don?t want to boast too much. That tends to invite bad luck and losses, which I would much rather avoid.

COPPER 11-20-15

GOLD 11-20-15

WTIC 11-20-15

DUG 11-20-15

NATGAS 11-20-15

 

FXY 11-20-15

UUP 11-20-15

Ship - TorpedoedWhat! No QE?

Stress Testing the Mad Hedge Fund Trader Strategy

It is always a great idea to know how bomb proof your portfolio is.

Big hedge funds have teams of MIT educated mathematicians that constantly build models that stress test their holdings for every conceivable outcome.

WWIII? A Global pandemic? A 1,000 point flash crash? No problem. Analysts will tell you to the decimal point exactly how trading books will perform in every possible scenario.

The problem is that these are just predictions, which is code for ?educated guesses.?

The most notorious example of this was the Long Term Capital Management melt down where the best minds in the world constructed a portfolio that essentially vaporized in two weeks with a total loss.

S&P 500 volatility (VIX) exceeding $40? Never happen!

Oops. Better get those resumes out!

That?s why events like the Monday, August 24 1,000 flash crash are particularly valuable. While numbers and probabilities are great, they are not certainties. Nothing beats real world experience.

As markets are populated by humans, they will do things that no one can anticipate. Every machine has its programming shortcoming.

Given that standard, I think the Mad Hedge Fund Trader?s strategy did pretty well in the downdraft. I went into Monday with an aggressive ?RISK ON? portfolio that included the following:

MHFT Trading Book

The basic assumptions of this book were that the long term bull market has more to run, the housing sector would lead, interest rates would rise going into the September 17 Federal Reserve meeting, the dollar would remain strong, and that stock market volatility would stay within a 12%-20% range.

What we got was the sharpest one-day stock decline in history, a 28 basis point spike up in interest rates, a complete collapse in the dollar, and stock market volatility at an eye popping 53.85%.

Yikes! I couldn?t have been more wrong.

Now here?s the good news.

When we finally got believable options prices 30 minutes after the opening I priced my portfolio, bracing myself. My August performance plunged from +5.12% on Friday to -10%.

Hey, I never promised you a rose garden.

But that only took my performance for the year back to my June 17 figure, when I was up 23% on the year. In other words, I had only given up two months worth of profits, and that was at the low of the day.

I then sat back and watched the Dow rally an incredible 800 points. Now it was time to de risk. So I dumped my entire portfolio. The assumptions for the portfolio were no longer valid, so I unloaded the entire thing.

This was no time to be stubborn, proud, and full of hubris.

By the end of the day, I was down only -0.48% for August, and up +32.65% for the year.

Ask any manager, and they would have given their right arm to be down only -0.28% on August 24.

Of course, it helped that I had spent all month aggressively shorting the market into the crash, building up a nice 5.12% bank of profits to trade against. That is one of the reasons you subscribe to the Diary of a Mad Hedge Fund Trader.

The biggest hit came from my short position in the Japanese yen (FXY), which was just backing off of a decade low and therefore coiled for a sharp reversal. It cost me -4.85%.

My smallest loss was found in the short Treasury bond position (TLT), where I only shed 1.52%. But the (TLT) had already rallied 9 points going into the crash, so I was only able to eke out another 4 points to the upside on a flight to safety bid.

Lennar Homes gave me a 2.59% hickey, while the S&P 500 long I added only on Friday (after all, the market was then already extremely oversold) subtracted another 1.61%.

The big lesson here is that my short option hedges were worth their weight in gold. Without them, the losses on the Monday opening would have been intolerable, some two to three times higher.

You can come back from a 10% loss. I have done so many times in my life. A 30% loss is a completely different kettle of fish, and is life threatening.

For years, readers complained that my strategy was too conservative and cautious, really suited for the old man that I have become.

Readers were able to make a lot more money following my Trade Alerts through just buying the call options and skipping the hedge, or better yet, buying the futures.

I didn?t receive a single one of those complaints on Monday.

I?ll tell you who you didn?t hear from on Monday, and that was friends who pursued the moronic trading strategies you often find touted on the Internet.

That includes approaches like leveraged naked shorting of puts that are always advertising fantastic track records...when they work.

You didn?t hear from them because they were on the phone pleading with their brokers while they were forcibly liquidating portfolio showing 100% losses.

Any idiot can look like a genius shorting puts until it blows up in their face on a day like Monday and they lose everything they have. I know this because many of these people end up buying my service after getting wiped out by others.

I work on the theory that I am too old to go broke and start over. Besides, Morgan Stanley probably wouldn?t have me back anyway. It?s a different firm now.

Would I have made more money just sitting tight and doing nothing?

Absolutely!

But the risks involved would have been unacceptable. I would have failed my own test of not being able to sleep at night. That is not what this service is all about.

In any case, I know I can go back to the market and make money anytime I want. That makes the hits easier to swallow.

You can?t do this without any capital.

With the stress test of stress tests behind us, the rest of the years should be a piece of cake.

Good luck, and good trading.

FXY 8-27-15

TLT 8-27-15

LEN 8-27-15

SPY 8-27-15

John ThomasSometimes It Pays to Be Old

The Party is Just Getting Started With the Japanese Yen

I?m sorry, but I just don?t believe that we will see a weak dollar potentially going into the first interest rate rise in nine years.

If my friend, Janet, pulls the trigger, then the greenback will become the only currency in the world that is raising rates. Currencies just don?t decline in those circumstances.

In that case, we want to go out and sell short the weakest link in the currency milieu, and that is the Japanese yen.

Even if Janet doesn?t move in September, the prospect will hang over then yen like a Damocles sword.

In addition, the yen is bumping up key chart resistance around ?125. A decisive breakout would clear the way towards ?130, my yearend target for the beleaguered Japanese currency.

A short in the yen is a safe, low risk trade right here in a world gone crazy.

?Oh, how I despise the yen, let me count the ways.?

I?m sure Shakespeare would have come up with a line of iambic pentameter similar to this if he were a foreign exchange trader. I firmly believe that a short position in the yen should be at the core of any hedged portfolio for the next decade.

To remind you why you hate the currency of the land of the rising sun, I?ll refresh your memory with this short list:

* With the world?s structurally weakest major economy, Japan is certain to be the last country to raise interest rates. Interest rate differentials are the greatest driver of foreign exchange rates.
* This is inciting big hedge funds to borrow yen and sell it to finance longs in every other corner of the financial markets.
* Japan has the world?s worst demographic outlook that assures its problems will only get worse. They?re not making enough Japanese any more.
* The sovereign debt crisis in Europe is prompting investors to scan the horizon for the next troubled country. With gross debt well over a nosebleed 280% of GDP, or 140% when you net out inter agency crossholdings, Japan is at the top of the list.
* The Japanese long bond market, with a yield of only 0.36%, is a disaster waiting to happen.
* You have two willing co-conspirators in this trade, the Ministry of Finance and the Bank of Japan, who will move Mount Fuji if they must to get the yen down and bail out the country?s beleaguered exporters.

When the big turn inevitably comes, we?re going to ?130 then ?150, then ?180. That works out to a price of $200 for the (YCS), which last traded at $94.93. But it might take a few years to get there.

If you think this is extreme, let me remind you that when I first went to Japan in the early seventies, the yen was trading at ?305, and had just been revalued from the Peace Treaty Dodge line rate of ?360.

To me the ?125 I see on my screen today is unbelievable. That would then give you a neat 17-year double top.

Japanese Lady-SadIt?s All Over For the Yen

A Note on Next Week?s Options Expirations

We have an options positions that is deep in the money, and I just want to explain to the newbies how to best maximize their profits.

This comprises:

S&P 500 (SPY) August $214-$217 in-the-money vertical bear put spread with a cost of $2.50.

As long as the (SPY) closes at $214.00 or above on Friday, August 21, the position will expire worth $3.00 and you will achieve the maximum possible profit.

This will worth out to a 20% gain, something you have been able to achieve in only 17 trading days. Better than a poke in the eye with a sharp stick, as they say.

In this case, the expiration is very simple. You take your left hand, grab your right wrist, pull it behind your neck and pat yourself on the back for a job well done.

Your broker (are they still called that?) will automatically use the long put to cover the short put, cancelling out the positions. The profit will be credited to your account on the following Monday, and the margin freed up.

Of course, I am watching these positions like a hawk, as always. If an unforeseen geopolitical even causes the (SPY) to take off to the upside once again, such as Janet Yellen announces that there will never be another interest rate hike again.

You should get the Trade Alert in seconds.

If the (SPY) expires slightly out-of-the-money, like at $214.10, then the situation may be a little more complicated, and can become a headache.

On the close, your short put position expires worthless, but your long put position is converted into a large, leveraged outright naked short position in the (SPY) with a cost of $217.50.

This position you do not want on pain of death, as the potential risk is huge and unlimited, and your broker probably would not allow it unless you put up a ton of new margin.

This is not what moneymaking is all about.

Professionals caught in this circumstance then buy a number of shares of (SPY) on expiration day equal to the short position they inherit with the expiring $217 put to hedge out their risk.

Then the long (SPY) position is cancelled out by the short (SPY) position, and on Monday both disappear from your statement. However, this can be dicey to execute going into the close.

So for individuals, I would recommend just selling the $214-$217 put spread outright in the market if it looks like this situation may develop and the (SPY) is going to close very close to the $214 strike.

Keep in mind, also, that the liquidity in the options market disappears, and the spreads widen, when a security has only hours, or minutes until expiration. This is known in the trade as the ?expiration risk.?

One way or the other, I?m sure you?ll do OK, as long as I am looking over your shoulder, as I will be.

Well done, and on to the next trade.

SPY 8-11-15

John ThomasWell Done and On to the Next Trade

 

 

?

Cashing in on the Greek Crisis

Try as I may, there is absolutely no way to escape a financial crisis in the modern world anymore, not even in the dusty, remote Western Sahara village of Taghazout, Morocco.

There is an Ebola Virus outbreak 1,000 miles to the south, and 35 British tourists were massacred on a beach in neighboring Tunisia last week. There were exactly four passengers on my flight from Lisbon to Morocco.

Was it a warning, or a confirmation of hubris?

Starving stray dogs and cats wander the street, garbage lines the beach, and raw sewage seeps into the ocean. Rangy, two humped camels vainly await riders at the edge of town.

But satellite dishes sprout from the rooftop of even the most forlorn, impoverished, broken down cinder block structures, and the hum of the global markets is never more than a few channels away.

The CNBC here is available only in Arabic, and is fiercely competing with Omani soap operas and the Iraqi Business Channel (yes, despite ISIS, there is such a thing).

But it didn?t take me long to figure out that the people of Greece rejected the ECB latest bailout proposal by an overwhelming 61.5% to 38.5% margin.

It was no surprise to me.

You would think that voting against punishingly higher taxes and an excruciatingly longer recession was a no brainer. But the markets were expecting otherwise, and have been caught seriously wrong footed. Poor summer liquidity is exacerbating the moves.

My somewhat passable French enabled me to discern that the prices were taking it on the nose. Japan and China each dove 2%, while Australia and the Euro pared 1% apiece.

This was going to be a ?RISK OFF? day on steroids.

Suddenly, I smell opportunity everywhere.

Now we know the kneejerk response to an imminent Greek default.

However, the cold, harsh reality of the situation requires a little deeper analysis.

CNN was utterly useless, choosing instead to focus on the human side of the tragedy, the freshly impoverished Greek goat herder and the island hotel operator who can?t pay his staff.

No great insight there.

Greek citizens are now limited to withdrawing 60 Euros a day from an ATM, if they can find one that has any cash at all. To head off a certain run and Armageddon, the Greek banks have all been closed for a week, with no reopening in sight.

Thousands of foreign tourists are now stranded in the land of moussaka, retsina, and Zorba, cursing their vacation destination choice.

So I?ll refer to my May conversation with former Greek Prime Minister, George Papandreou, who ran the country from 2009 to 2011, and shepherded the country through the post financial crisis 2010 debacle.

His late father, Andreas, was also a Prime Minister, as was his grandfather, Georgio, who spent time in jail for his services, consider running this ungovernable country the family business.

To a large extent, the ECB (read the Germans) are in a subprime crisis entirely of their own making.

German banks provided funds to their Greek counterparts, initially to build the $8 billion 2000 Athens Olympics, which was almost entirely subcontracted to German engineering firms.

They then fueled the economic boom that followed, making possible the export of tens of thousands of Mercedes, BMW?s and Volkswagens. That bankrolled a major increase in the Greek standard of living, while adding several points to German GDP growth.

When dubious financial statements were presented to justify this lending binge, bankers simply winked, and looked the other way.

A decade and a half later, they are ?shocked, shocked? that some of the accompanying disclosures were inaccurate, as police inspector Claude Rains might have said in Casablanca (which, by the way, is only 400 miles north of here).

?Gambling in the casino? Perish the thought.? How do you say that in German?

The reality is that this is all a storm in a teacup. Accounting for only 2% of European GDP, it is neither here nor there whether the country stays or goes from the European Community or the Euro.

Total Greek debt to the ECB is now $3.5 billion, a drop in the bucket in the global scheme of things.

What?s more, this crisis is far less serious than the ones that occurred in 2010 and 2012. This time around, Greek bonds have already been taken off the books of German and French banks at cost, and placed with numerous multinational agencies, largely the ECB itself.

What is almost completely lacking here is private risk, unless you happen to own a Greek bank, or the shares of other Greek companies.

What?s more, all of this is happening in the face of a massive 60 billion a month ECB quantitative easing program. The amount Greece owes comes to less than two days worth of this amount.

Never take a liquidity crisis in the middle of a structural global cash glut too seriously.

Even this paltry amount can be easily refinanced by the International Monetary Fund on a slow day. That?s what they are there for.

This pales in comparison to the 39 billion euros spent to bail out the Spanish banking system a few years ago, or the $4 billion IMF rescue of the United Kingdom in 1976.

In the end, the amounts are sofa change to the Chinese, who are starved for high yield investments. It was they who nailed the top of the last European bond yield spike (on my advice, I might add), acting as the buyer of last resort then.

In the end this will be solved, as have all international debt crises since time immemorial, since the British seized the Suez Canal from the French as collateral for bad debts in 1882. Extend and pretend. Move debt maturities out another ten years and hope everything gets solved by then.

It always works.

What all of this does do is create a great buying opportunity for the assets not directly involved in this crisis, notably US equities. Modest over valuation has encumbered main indexes with declining volumes, narrowing breadth, and shrinking volatility for all of 2015.

At the very least, the Euro crisis du jour will present a second test of the (SPY) 200-day moving average at $205.74. The best case is that it gives us a real gift, a visit to a full 10% retreat to $193, a pullback whose ferociousness has not been seen since October.

That?s where you load the boat for a rally to new index highs at yearend.

You can expect similar moves in other assets classes.

In this scenario, volatility (VIX) will rocket to 30%. The Euro (FXE) collapses to $103 once more, and the Japanese yen (FXY) revisits $82. Treasury bonds (TLT) enjoy a flight to safety bid that takes yields at least back to 2.30%. Gold (GLD) and silver (SLV) do nothing, as usual.

For followers of my Trade Alert service, this is all a dream come true. Having made 26.71%, or much more, in the first half of this year, you now have the opportunity to repeat this feat in the second half.

Going into a crisis like this with 100% cash and only dry powder is every trader?s wildest fantasy. Make sure you let the current Greek debt crisis play out before you commit.

This is what you all pay me for. At least I?ll get something for suffering through the hell holes and gin joints of West Africa.

I think I?ll go give those camels some business.

SPX 7-2-15

TLT 7-2-15

VIX 7-2-15

FXE 7-2-15

George Papandreou

RetsinaRetsina

John Thomas

The Global Impact of the New Japanese IRA?s

Nearly two years ago, the Japanese government introduced the Individual Retirement Account for individual investors in Japan for the first time.

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

Starting October 1, 2013 individuals have been permitted to contribute up to ?1 million a year into Nippon Individual Savings Accounts (NISA) or some $8,000, while married couples can chip in ?2 million.

These funds are 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 0.41% as of today. That doesn?t buy you much sushi in your retirement.

Over the past three years, Japan has enjoyed having 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 0.5% in Europe.

Early indications are that the NISA?s are 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. That certainly makes Japanese brokers, like Nomura (NMR), a buy. Another of my favorites is Sony (SNE).

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 four years ago, the Japanese stock market (DXJ) has soared by an amazing 176% in US dollar terms. The short Japanese yen 2X ETF (YCS) has similarly rocketed by a huge 232%.

Regular readers of the Mad Hedge Fund Trader have been mercilessly pounded to buy Japanese stocks and sell short the Japanese yen for the best of three years. I can almost hear ?Oh no, here comes another yen bashing piece!?

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?).

DXJ 6-2-15

YCS 6-2-15

NMR 6-2-15

SNE 6-2-15

 

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