August 29, 2003

Unrestricted Warfare and the Dollar

This post is more like an essay. I'm trying to put a table of contents at the top here so you can quickly scan what's new and jump to what's interesting to you, rather than having to scroll. Be patient with me. (Meditate, if it helps...outside the office right now I hear the chanting of a a Buddhist(?) monk who comes by the window about the same time every night...his voice sounds just like a didgeridoo...amazing.) In the meantime, this is another example of the kind of content--in addition to the investment content--that this medium allows me to publish. It's a more detailed exploration than I could undertake in an e-mail or a monthly issue. And since I'm not actually sending it to you, I assume I'm not imposing. And if you really really think it's too long...stop reading. Otherwise...enjoy. Unrestricted Warfare and Destroying the Dollar “If it wanted to, and if it were smart enough, how could a terrorist organization destroy the U.S. dollar?” This is the question I posed to myself last night over a few beers at my favorite bar, just off rue St. Denis. It wasn’t originally my question. It was posed to me by a reader at the conference in San Francisco. This reader happens to be a Naval Reserve officer. And he and his professional friends do a lot of thinking about what terrorists may or may not be plotting against American interests. “How they might come after the dollar,” he said, “is what keeps the intelligence boys up at night.” The premise of this line of thinking is simple: If you really wanted to cripple the United States, or even send it back to the Middle Ages, you wouldn’t bomb its buildings, bridges, buses, or bourses. You’d destroy its currency. It’s the dollar that gives America its power, the thinking goes. It’s the dollar that makes America strong. It’s the dollar, and the willingness of foreigners to own it via U.S. stocks and bonds that is the source of American strength. It’s the strong dollar that pays for aircraft carrier groups, precision guided missiles, Stryker brigades, and the C-17s that fly American men and weapons to all four corners of the globe. Destroy the dollar, and you destroy America. Practically speaking, there are probably things you COULD to the physical currency to sow chaos in financial markets. You could counterfeit your enemy’s money, like the British did in the Revolutionary War (while they paid their own debts in gold.) Or you could sprinkle anthrax at an ATM in the heart of a major city. That would complicate the use of physical money. Of course there are a lot more digital dollars than real dollars these days. No one knows exactly how many. But the Depository Trust Clearing Corporation clears $1 quadrillion worth of trading activity every year. I’m not even sure what that means, but it amounts to about $3 trillion and 4 billion trades a day. It does all that clearing on computers located at facilities located all over the country. In one of his novels, Tom Clancy had terrorists destroying one of those facilities and vanquishing Wall Street into the ether. Today, they’d have to find them. Then there’s the Federal Reserve, which clears all international trading in dollars. A reader on the message board wrote the following. Although I can’t vouch for its accuracy, it seems plausible: On 9/21/01, I attended a small, private meeting where a senior official of the Fed. Reserve briefed us on the recent calamity in New York. Some of his comments were startling. The New York Fed. Reserve was knocked out by cables that ran under the collapsed buildings. (not reported in the press) The New York Fed is the clearing house for ALL international trading in dollars. The rest of the Fed districts stepped in to share the load and to continue the world trade in dollars. There was a run on the banks in Florida. Little old men and women ran to their bank and demanded all of their assets in cash. The Fed was able to keep this out of the media. In order to stem any further panic, the Fed started injecting 100 billion a day into the system. We were informed that the "normal" cash injection was 1 billion a day. As of our meeting date (9/21/01) they were still injecting at that rate. Our speaker informed us that these funds would be removed from the system when things got back to normal. Then, during a Q/A session that followed his presentation, I asked a "doomsday " scenario question like, "What is your fallback if all your actions are futile?" His response startled me. His words. "We at the Fed will to anything, including direct intervention in capital markets, in order to stabilize the situation." If you really wanted to attack the dollar, you’d attack the electronic clearing systems that make dollar-denominated trade possible. Right? I suppose all of this is possible. But as I was thinking about all this I thought two things. First, the dollar is not really the source of American wealth. A currency doesn’t make a country rich. A sound currency is, perhaps, accompanies a wealthy country. But it’s not the paper that makes you rich. It’s the factories, property, raw materials, labor, knowledge, and skill that are the real source of wealth. Paradoxically, a currency can’t make you strong. In fact, all it can really do is make you weak. Even it’s strength, for America, has been its weakness. The strong dollar has made it possible for Americans to acquire lots of cheap goods and services. But it’s also encouraged a structural shift in the American economy that FAVORS consumption over production. And now, our dollar is our Achilles heel. If foreigners aren’t willing to own it, the dollar will have to depreciate and American standards of living will have to fall. Second, who needs a terrorist to accomplish what the Central Bank is achieving with stunning success. Without a box cutter, and without firing a shot, blowing up a bus, or hijacking an airplane, Greenspan et. al have already done more damage to the dollar than any al Qaeda operative ever could. Who needs an enemy to counterfeit your currency when your own bankers can do it themselves? And all perfectly legally, with the approbation of the public? As an investment question, there’s not much you can do about preventing a theoretical terrorist attack on the dollar. But there IS something you can do about the Fed’s attack. Short bonds. Think of the U.S. government as a company. Its main product is dollars. That product is defective. The proxy for that product is the government bond, which is a call on future dollars, and trades openly in the market. I’ve written a lot about shorting the dollar via bonds this week. So I won’t elaborate here. Nor will I elaborate on the other way to be short the dollar…by being long gold. We’ve spent a lot of time on that too. If you haven’t seen those posts, pay special attention to the chart below showing the ratio between Gold and U.S. T-bonds. This ratio represents, as my trading friend Greg Weldon says, the “Ultimate Battle Between Paper and Gold.” As you can see from the chart, bonds creamed gold for 15 years. That trend is now reversing. Of course you have a risk either way…being short bonds or long gold. The Fed can be the buyer of last resort in the bond market (or encourage the Japanese to buy) and it can be the seller of last resort in gold (although no one can be really sure how much gold is really left in Fort Knox, or if it’s all been leased away to the bullion banks, never to be seen again.) No matter which way you slice it, the real battle in financial markets is not between al Qaeda and the dollar. It’s between paper and gold. And gold is starting to win. But don’t expect paper to go down without a fight.

Gold at $416

I am not a technician when it comes to gold. My reasons for recommending it and owning are many and varied, but mainly a deep and abiding suspicion of Central Banks and paper backed by nothing. I think Bill Bonner is right that taking the U.S. off the gold standard was indeed, "Nixon's" sin. But some of my best friends are technicians. They don't share my passion for discussing monetary policy. But even THEY believe gold is reaching some important technical milestones. The best of my tehnician friends is Greg Weldon (, although to be fair to Greg, he also has a unique command of the macro economic factors that act on the stock market his well. He's just one of those guys that happens to be good at everything he turns his attention to. And lucky for me, his attention is usually focused on the same financial themes mine is focused on. Like gold. Take a look at the chart below. This chart is a long-term chart of gold futures. In his daily Metal Monitor commentary, Greg says, "Of specific, bullish, long-term technical interest, as plotted in the monthly gold chart above, we note: *Confirmed upside violation of downtrend line in place since 1987 *Massive inverted head-and-shoulders bottoming pattern *Mega-long-term 36-month Moving Average trending higher *Moving average at highest level since 1999 "Can anyone say gold at $416? How about $502?" Three other important things to watch in the gold price, according to Greg. First, if gold closes today above the weekly close of $369.90, it would represent a new bull move WEEKLY closing high. Second, If gold closes August above the monthly close of $368.30 (set in Jan. 03) it would represent a new bull move MONTHLY closing high. And finally, if gold violates the bull move intra-day, intra-week, intra-month high of $384, it would represent a new bull move MULTI-YEAR high. Notice a pattern here? And then there's the gold/U.S. T-Bond Ratio. Yesterday I speculated that the big move in uh-hedged gold stocks on the HUI, coupled with the undersubcribed 2-year treasury auction, suggested that dollar disinvestment has begun. If you want a picture that explains it lot more succinctly, look at this...

Hilllary for President?

And you thought I was joking when I said in San Francisco that Hillary Clinton would enter the Presidential race...and win. We still don't know about the win part. Or even the enter part. But Drudge picked this story up from with this key graph: Hillary and her advisers will meet shortly after Labor Day, I hear, to discuss whether or not she should go for it. Senator Clinton is in the same high-stakes dilemma as one of her predecessors was 35 years ago. In 1968, New York Senator Robert F. Kennedy was the most celebrated Democrat in the country after President Lyndon Johnson announced he would not run -- after almost being defeated in New Hampshire by a critic of the war in Vietnam, Senator Eugene McCarthy of Minnesota. Kennedy threw caution and old non-candidate promises to the wind and entered the contest against McCarthy and Hubert Humphrey. There are great similarities between then and now, and between New York’s carpetbagger senators -- Bobby from Massachusetts, Hillary from Arkansas -- beginning with their name recognition, their armies of admirers and enemies and their dominating position in polls.

U.S. Made Deal to NOT Get Bin Laden?

Never can tell..but it's certainlly plausible that this kind of thing happened. After all...part of the Administration's strategic goal in taking down the Taliban to the East and Hussein to the West was to put Iran in the crosshairs of two U.S.-led governments (not to mention putting the squeeze on Syria as well). But all of that stragic logic falls apart if killing Bin Laden causes Musharraf to lose power in Pakistan. Then, suddenly, you have U.S. forces in Afghanistan sandwiched between the Mullahs in Tehran and the Mullahs in Islamabad. Not exactly friendly confines if you're a secular nation buidler. Here' an excerpt from the article if you don't want to follow the link. (By the way, anything that appears blue within the text of a post is a link to the source of the information or a site of interest that pertains to the article I've written.) UK newspaper The Guardian reports that Mansoor Ijaz, chairman of Crescent Investment Management and insider in the shadow world of international affairs, is making the sensational claim that the U.S. and Pakistan have made a deal not to arrest Osama bin Laden -- for now. Ijaz also says he knows where bin Laden is hiding. Excerpts: Bin Laden fled the [Tora Bora] mountains and spent the next six or seven months trying to re-establish his network, according to Mansoor Ijaz, a financier who has spent years tracking his movements and operations. In the small world of international terrorism analysts, Mr Ijaz, an American of Pakistani origin, knows al-Qaida better than most. Mr Ijaz argues that the flight from Tora Bora badly disrupted al-Qaida's access to electronic communications: satellite phones, radios and email. "Initial communications were stopped and it took them a while to transplant and regroup," he said in an interview. "It was in a place where it was impossible for them to get communications across to anybody." He suggests Bin Laden is hiding in the "northern tribal areas", part of the long belt of seven deeply conservative tribal agencies which stretches down the length of the mountain ranges that mark Pakistan's 1,500-mile border with Afghanistan. Mr Ijaz, who has recently visited Pakistan, believes Bin Laden is protected by an elaborate security cordon of three concentric circles, in which he is guarded first by a ring around 120 miles in diameter of tribesmen, whose duty is to reportany approach by Pakistani troops or US special forces. Inside them is a tighter ring, around 12 miles in diameter, made up of tribal elders who would warn if the outer ring were breached. At the centre of the circles is Bin Laden himself, protected by one or two of his closest relatives and advisers. Bin Laden has agreed with the elders that he will use no electronic communications and will move only at night and between specified places within a limited radius.

Getting Outside the Dollar

It was odd that U.S. government bonds rallied yesterday on the kind of news that usually leads to selling. Strong GDP growth usually causes selling in Treasuries. In a growing economy, investors would rather own stocks or higher yielding emerging market debt. Of course, maybe investors are on to the fact that this isn’t your garden-variety recovery. Either way, the 10-year note was up 23/32 point, and its yield fell to 4.428% from 4.521%. The 30-year bond was up 1 1/32 points and its yield moved down from 5.297% to 5.227%. My options service subscribers may own calls on TLT, Lehman’s 20-year bond index fund. TLT was up 1% yesterday, although in the interests of full disclosure I should point out that so far the calls I selected are up only about 3% from our August 11th, entry price. Still, not bad, making a little money on bond calls during a bond bear market. Buying calls on a bond index isn’t something your average investor could have done even 5 years ago. In fact, the entire fixed income market was sort of a private investment preserve, only accessible to high net-worth investors who were moving around big chunks of a sizable portfolio. But not anymore. Now trading or investing in the bond market is as easy as buying or selling a stock through Ameritrade. Everyone can be a bond vigilante. (More on this later today when I look in depth at how to “Make Uncle Sam Pay.”) The only kind of bond trading still off-limits to retail investors is junk bond investing (or investing in high-yielding bonds). You can, as I’ve mentioned here, buy corporate bonds through LQD, another bond ETF that allows you to go “short” or “long” corporate debt easily. But so far, there’s no equivalent ETF for emerging market debt, which, while not always junk, is typically higher risk/higher yield. In fact, it wasn’t even until April of this year that you could invest in emerging markets through a PGI. Prior to that, you had to take your chances in a mutual fund (higher fees), or look for particular American Depository Receipts. I’ve recently added the iShares Emerging Market Index Fund (EEM) to the SI portfolio. It’s not exactly emerging market debt. But it’s about as close as you’re going to get and still be able to buy it and sell it like a stock. Options don’t trade on EEM yet, unfortunately. I think it’s just a matter of time, though. Meanwhile, EEM's top tend holdings are: 1. Samsung Electronics 5.99% 2. Angle American 4.09% 3. Telefonos de Mexico 2.28% 4. China Mobile 1.98% 5. Teva Pharmaceutical Industries 1.97% 6. Taiwan Semiconductor 1.85% 7. Lukoil Holding 1.43% 8. Kookmin Bank 1.34% 9. Posco 1.31% 10. Sasol 1.28% Are there some stocks among those top ten I wouldn’t buy on their own? Sure. In fact, I’m bearish on the whole semiconductor sector. It’s highly unlikely I’d own Taiwan semiconductor. On the other hand, I’m already long Sasol in the SI portfolio. I get two main benefits from EEM. First, I can invest specifically in the idea that investors will look outside the U.S. for better growth opportunities. Second, I get some diversification, geographically and across sectors with EEM. Seems contradictory, specification WITH diversification. But it’s true. And so far, EEM is up about 10% from our entry price. Of course, the premise of the whole idea is that investors are tiring of buying the same old former bull market leaders and the same old tired U.S. bonds. The proof, it seems to me, is already rolling in. And EEM is relatively new. The higher profile it comes, the more popular I believe it will become. A NEW WAY TO INVEST IN EMERGING MARKETS WITH LESS RISK Today’s Wall Street Journal reported that “investors have bid emerging-markets bonds to their strongest level in five years.” The article goes on to caution that, “the supply-demand situation could shift against emerging-markets issuers” and that “Emerging-markets nations may soon find themselves in stronger competition to borrow internationally with the U.S. government.” Competition indeed. The tone of the article seems to suggest that if investors are forced to choose between buying an ever-increasing supply of U.S. debt and emerging market debt, they’ll choose U.S. debt. Well…it HAS been true for the last 10 years. But as I showed yesterday, the world’s voracious appetite for U.S. debt may be diminishing…primarily because the U.S. government projects nothing but greater and greater deficits for the next 10 years. It really comes down to whether you believe investors will continue demanding U.S. bonds, no matter how large the deficit gets. Vincent Truglia, co-manager of Moody's Investors Services' sovereign risk unit, said in the Journal article that "A large [budget] deficit, keeping everything else equal, means the U.S. will be the largest drawer upon world savings," making less money available for emerging-market countries, he said.” Maybe. But only if the world keeps lending its savings to a belligerent American government that’s financing its war machine with the export-driven profits of emerging market countries. And THAT is an issue which deserves a much fuller treatment, which I’ll get to later this afternoon. For now, beware bonds.

A New PGI for TIPS in the Works

Saw this earlier today...good news if you're looking for an easy way to buy inflation indexed bonds...or better yet, sell the heck out of them with put options. Actually, no word yet on whether options will trade on the new TIPS ETF. I'll keep you posted. 08/20/03 SEC Takes Steps to Make the First TIPS and Broad U.S. Bond Market Exchange Traded Funds Available to Investors SAN FRANCISCO, August 20, 2003 — The U.S. Securities and Exchange Commission took action to authorize the creation of new fixed income iShares exchange traded funds (ETFs). The iShares Lehman U.S. Treasury Inflation Protected Securities and U.S. Aggregate Bond Funds are scheduled to launch on the American Stock Exchange in the 4th quarter of this year, pending issuance of all regulatory relief by the SEC. Each fund will have an expense ratio of 0.20%, beating the average expense ratio of 0.42% of bond index mutual funds.¹ The iShares Lehman U.S. Treasury Inflation Protected Securities Fund will be designed to track the Lehman Brothers U.S. Treasury Inflation Notes Index that measures the performance of the inflation protected public obligations of the U.S. Treasury, also known as "TIPS." The iShares Lehman U.S. Aggregate Bond Fund will be designed to track the dominant broad U.S. investment grade bond index that includes multiple asset classes and maturity ranges. "Our clients have been asking for more fixed income iShares since iShares launched the first four fixed income ETFs in July 2002, so we're pleased that the SEC has taken action," said Lee Kranefuss, CEO of BGI's Intermediary Business. "Many institutional and individual investors are seeing fixed income iShares as an investment solution to the volatile bond market. The iShares Lehman U.S. Aggregate Fund will provide investors with fixed income exposure across multiple sectors in a single trade, while the iShares Lehman TIPS Fund may be of interest to investors who think inflation will rise." "With fixed income iShares investors also enjoy the added benefits of cost efficiency, transparency of price and holdings, and the ability to purchase a basket of bonds with the ease of buying a stock," Kranefuss added. iShares are index funds that are bought and sold like common stocks on national securities exchanges as well as certain foreign exchanges. iShares are attractive because of their relatively low cost, tax efficiency and trading flexibility. Investors can purchase and sell shares through any brokerage firm, financial advisor, or online broker, and hold the funds in any type of brokerage account. Fixed income iShares are the only fixed income ETFs available to U.S. investors.

Where the Money is Flowing: Oil

Dow bears did all their work by 10:30 a.m. yesterday, and then apparently got a head start on a Labor day weekend. After getting as low as 9,246, the Dow spent the rest of the day rallying, and closed up 128 points from the session low. Still, the most active stocks were almost all Nasdaq stocks. And once again, the QQQs are still the preferred way to be a tech bull (just as the new gold ETF will be the preferred way for the retail investor to be a gold bull). The S&P ETF, the “Spiders,” cracked the top ten as well. More proof that buying baskets of stocks in the same industry, sector, country, or asset class is a better risk than individual stocks. The top ten most actives: 1) QQQ, up 0.88% 2) INTC, up 1% 3) MSFT, up 0.34% 4) ORCL, up 2.57% 5) CSCO, up 0.95% 6) SUNW, down 0.79% 7) SPY, up 0.62% 8) AMAT, down 0.37% 9) JDSU, down 0.31% 10.) ADC, up, 7.49% Yet despite being the most actively traded stocks in the country, none of those stocks made it into the top ten in terms of money flow. Money flow tells you how much money is coming into or leaving a stock, after all the buys and sells are reconciled. Of course a lot of new money flowing into a stock doesn’t mean the stock is a buy. It just means a lot of new money is flowing into the stock. And it tells you something about where the “big money” is going. Yesterday’s top-money flow gainers were: 1) Exxon +$59 million 2) GM, +$59 million 3) AOL, +54 million 4) Wells Fargo, +$48 million 5) Amgen, +$35 million 6) Interpublic, +$34 million 7) Lowes Cos, +$30 million 8) ChevronTexaco, +$28 million 9) eBay, +$28 million 10) Schlumberger, +$26 million Anything catch your eye? Exxon, Chevron, Schlumberger perhaps? Yesterday I predicted a good day for oil service stocks based on higher crude prices and the constant geopolitical tension coming out of Iraq. Look at the chart below and you’ll see what I mean. SERVICES CRUSH INTEGRATED MAJORS The chart shows the Oil Service Holders (OIH) and Halliburton taking off at 10:30, while the Amex Oil Index of integrated majors (XOI) and Exxon logged more modest gains. OIH finished the day up 3.16% and HAL finished up 3.89% There was no major economic news to explain why the service stocks outperformed the majors. There was this bit, though, from, which, by the way, reinforces the idea that buying futures on any index or asset (the Dow, S&P, gold, or oil), can influence the cash index. “Oil service stocks rallied smartly in midday trading Thursday, boosted by strength in energy futures…In commodities trading on the New York Mercantile Exchange, October crude rose 32 32 cents to $31.53 a barrel…” In fact, every single one of the 18 stocks in OIH was up yesterday. Of course, it’s not realistic that you would have bought EVERY single one of them. That’s really the point though, isn’t it? With vehicles like OIH, you don’t HAVE to buy every single one and take 18 different risks. You have one risk. And that one risk is leveraged to benefit if you’re right about your idea. MARKET IMPLICATION: 61 IS A KEY LEVEL FOR OIH. IF IT CAN BREAK OUT OF THAT, IT’S CLEAR TECHNICAL SAILING UP TO ABOUT TO ABOUT 70, THE LEVEL IT LAST SAW IN MAY OF LAST YEAR.

August 28, 2003

Poulet et Vin Rouge

Worked the last few hours on a short piece about currency to take down the economy by taking down the dollar. It was spawned by a conversation I had with a subscriber at the San Francisco conference. The whole issue also touches on how to pay for a global war when your currency falls in value....could get tough to do. More tomorrow. Meanwhile, a few folks wrote back and asked me if I'd become a gourmet food snob since moving to France. The answer is no. In fact, last night, my dinner went something like this.... PLUS The best of both cultures. The only mistake I made was telling Francoise, who sits next to me here in the office. She looked at me somewhat shocked and said, "The poor wine! How could you do that to it?"

Too Much Stuff

A few readers wrote in saying there was too much to read. Never fear. What you saw earlier was three days of material. I've changed the settings so now you see only today's posts. If you want to see previous days, go to the archives button below the pictures of the books on the right and pick the day you want to view. And if it's STILL too much material, or you have a suggestion for what you'd like see less (or more) of, let me know by clicking on the "Post Comments" or "Send Comment" links to the right..

It Has Begun

Let’s put the pieces together. 1.) Dollar disinvestment has begun (see below). 2.) Budget deficits are rising (see below). 3.) Gold is rising- especially the unhedged majors. The Amex Gold Bugs Index (HUI) was up 11 points and over 6%. Remember what I mentioned yesterday that large-scale speculators both added to their long positions and reduced their shorts. The financial world is de-leveraging from the dollar. It starts with the government not being able to sell all its two-year bonds. It starts with $400 billion annual Federal deficits. And it starts with one last blow-off rally in tech speculation as the old paradigm breathes its last breath. It ends with an ounce of gold buying you a share of the Dow. If you’re worried that the HUI is overbought near term, you MAY be right. But take a look at this long-term HUI chart. The HUI is just now reaching the levels it was at when the tech boom started--when investors had written off gold for dead. Gold, however, has risen from its 6-year grave on the HUI. It has begun.

Yesterday's Market Action, Short Chips, Long Oil and Gold

The tech mania is back. And you can thank the analysts for producing it. But it is giving us more proof that even if you have the right idea at the right time, investing in single stocks is riskier than your exchange traded fund alternatives. A fuller article on “market timing” is in the works. But first the numbers and an idea. The top ten most active stocks on the market yesterday were, with one exception, all retreads from the last bull market. Take a look: 1) Intel (INTC), up 1.12% 2) The Q’s (QQQ) up 0.80% 3) Oracle (ORCL) up 0.08% 4) Cisco (CSC), down 0.47% 5) Microsoft (MSFT), down .0.56% 6) JDS Uniphase (JDSU), up 3.24% 7) Sun Microsystems (SUNW), unchanged 8) Applied Materials (AMAT), 3.34% 9) Pfizer (PFE), down 0.33% 10) Qualcomm (QCOM), up 3.90% Lots of chipmakers. And not by accident. You have to wonder if all the chip analysts called each other on Tuesday night and decided to be wildly bullish on Wednesday. Brokerage firm Harris Nesbitt Gerard raised its forecast for chips from “negative” to positive. Merrill Lynch “reiterated” its positive forecast. Bear Stearns chimed in by upgrading Fairchild Semiconductor to “outperform” from “peer perform.” Stocks rising on analyst ratings. Who woulda thunk we’d see that again after the last two years? But rise they did. In fact, the Nasdaq hit a new 16-month high. The Philly Semiconductor Index (SOX) was up 2.96%. The Morgan Stanley Internet Index (MII) was up 2.93%. And the AMEX disk drive index (DDX) was up 2.22%. There are two investment conclusions you can draw from this action. First: during secular bear markets, it’s the most speculative stocks that lead the rallies, hence techs leading the way. Second: if you’re going to speculate, as either a bull or a bear, it makes a lot more sense to do it with exchange traded funds and the whole new breed of index, geographic, or sector specific funds that I’m calling PGIs. Case in point, a would-be tech bull trying to figure out how to play a rally could have picked the biggest, baddest, tech stock in the bunch and gone long or bought calls. But if you had picked Microsoft, you would have missed the rally. If you’d picked JDSU, you were in luck. That’s not very efficient risk management. And it’s totally unnecessary these days. For example, the MII is made up of 25 Internet-related stocks, including MSFT, ORCL, and CSCO. Had you bought each of those stocks individually, you would have been up modestly in ORCL and CSCO, but down enough in MSFT to lose it all--this on a day when the Nasdaq reached a 16-month high and the MII itself went up nearly 3%. Even if you had the right idea for the day (bullish tech) you’d have the wrong strategy and probably the wrong individual stocks. Your best strategy is to own the type of investment that gives you the best chance to profit from your idea with the least amount of risk. INVESTMENT IMPLICATION: Take a look at IAH, the Internet Architecture HOLDERS. This gives you exposure to, among others, CSCO, DELL, SUNW, and 3COM (COMS.) I’m looking at it on the short side, sitting on its 50-day moving average, holding on for dear life. MARKET IMPLICATION: It’s a speculator’s market right now. Look for in-the-money puts on indexes that are overextended. And on the long side, look for calls on gold, gold indexes, and gold stocks. In particular, look below for OIH, the oil service holder, to break out above 61 on both escalating geopolitical tensions and the new contract awarded to Halliburton for rebuilding Iraqi oil infrastructure. Even HAL calls don’t look like such a bad idea. But why take the risk on HAL when you can own it as part of OIH and get the rest of the sector too?

Dollar Overcapacity

In the Setpember issue of Strategic Investment (which by the way you'll be able to get online today) I write about "Dollar Disinvestment." It's the idea that sooner or later, there will be so many dollars in the world, and so much government, corporate, and consumer debt, that ivnestors, especially foreigners, will no longer want to own dollars. Exhibit A: here, in black and white terms: "Treasury prices extended early losses on Wednesday after an auction of new two-year paper drew only tepid demand at a time when the supply of government debt is ballooning." Supply doesn't always create its own demand. This is debt/dollar overcapacity. And it's going to affect the ability of the U.S. government to finance its debt and its wars. Reueters reports that "The $25 billion of notes fetched a yield of 2.04 percent having steadily climbed from 1.97 percent in when-issued trading this morning. The sale drew bids for only 1.73 times the amount on offer, just below the 1.80 average of the last three auctions." And there's this revealing quote from Michael Cloherty at CSFB, "It looks like foreign central banks were reluctant to show up for this sale." There will be a lot more reluctance in the future if the the Congressional Budget Office figures on the Federal deficit are right. CBO now projects a $400 billion for this year. That's $150 billion more than before the war in Iraq. CBO says over the next 10-years the deficit could reach $1.4 trillion. And this does not include the $400 billion required to pay for the new Medicare prescription drug benefit. Nor does it include the billions more the President is about to ask Congress for to help rebuild Iraq. The President's own man in Iraq, Paul Bremer, says the Iraqi reconstruction could cost as much as $100 billion by the time it's all done. (not bad news if your'e Bechtel, which had its contract for Iraqi reconsruction almost doubled yesterday by $350 million dollars.) But how are bonds and the dollar reacting to the higher deficits and the lukewarm treasury auction? Take a look at a 3-month chart, courtesy of, that shows falling bond prices on the two indexes that I use to trade government bonds. IEF is Lehman's 7-10 year bond index. TLT is its 20-year bond index. Obviously, bond prices are falling. I WAS looking for a rally. But once real dollar disinvestment begins, there's no telling how far prices could fall, or how high yields could rise. What about the dollar? The dollar is up to about $1.08 against the euro in early trading this morning in London. U.S. GDP numbers come out today. And the market expects them to be better than previous estimates. This is just how the bulls envision it: superior economic growth in the U.S. supports the dollar and the stock market. And it's true, the dollar is up about 9% from its May 27 low of $1.19 against the euro. Yet two obvious facts are ignored in the press reports. First, a stronger dollar makes the current account deficit worse. It makes American goods more expensive...and cuts any expansion off at the knees. Over time, this is bad for the dollar, not good. Second, and more importantly, it would take a much higher level of economic growth to escape the drag of a growing Federal deficit. What we have here is a giant game of risk assessment. I'll write more on this later today. If you choose to own dollars now (buy U.S. bonds or stocks), you're betting that higher U.S. growth will make the dollar more appealing than the euro, the yen, or gold. But your risk is that the growth isn't real economic growth. Your risk is that today's higher GDP numbers are caused by the tax cuts and government spending. Will this "stimulus" be enough to actually create new economic growth, to pare the unemployment roles, to reverse the outsourcing of blue and white collar jobs, and erase the $32 trillion in aggreage U.S. debt? I think not. IMMEDIATE INVESTMENT IMPLICATION: LOOK FOR FALLING BOND PRICES TODAY, A MODEST RISE IN STOCKS, BUT WEAKNESS IN THE DOLLAR AND STRENGTH IN GOLD. TRADERS COULD BUY PUTS ON TLT AND IEF.

August 27, 2003

Fisking the Closet Marxists

On my way home for dinner before I settle down to see how the markets finish. But before I left I figured I’d publish a response to an e-mail I got from an old friend who’s a closet Marxist, but tries to appear reasonable. This is precisely the type of thing I’d never take your time with if I was sending it to you via e-mail, or heaven-forbid, in a 16-page monthly letter. But since we’ve got the space, I thought I’d put it up here. I call it a fisking, which means more than this link suggests. It means exposing a really bad idea for what it is. It began with this email: Folks -- Please see below a particularly provocative excerpt from a rhetoric discussion list. I'm not sure what I think on this subject, but it calls attention to the potency of language and thinking in metaphors. Can words, metaphors take on momentum beyond the control of the speaker? How often do we lazily embrace such "idea packets" into our thinking without making the effort to examine their concepts ourselves? Certainly, an honest skepticism about the wonders attributed to the metaphor of the "invisible hand" seems sound. Here’s the excerpt: "Figures of speech are not mere frills. They think for us. Says Heidegger, 'Die Spracht spricht, nicht der Mensch': The language speaks, not the human speaker. Someone who thinks of a market as an 'invisible hand' and the organization of work as a 'production function' and her coefficients as being 'significant,' as an economist does, is giving the language a lot of responsibility. It seems a good idea to look hard at the language." -- Exordium to McCloskey's _Rhetoric of Economics_, 2nd ed., xix And here’s my response… “Certainly, an honest skepticism about the wonders attributed to the metaphor of the "invisible hand" seems sound.” my friend, who shall remain anonymous (how bout an honest inquiry into what the metaphor means?? does that seem sound…or is there too much of a presumption of intellectual innocence I’m giving to the term?) Tom, You ask good questions. I want to answer them and rephrase them, all in the spirit of "looking hard at the language." You ask: Can words, metaphors take on momentum beyond the control of the speaker? Definitely. Just ask Trent Lott. Or Cruz Bustamante, the Deomcractic leader in California who accidentally used the word “nigger” in a speech he was giving to labor groups…and despite a pro-labor record, got roundly trashed by labor leaders. But in those cases, the speaker neither intended nor desired the response he got. I think we’re probably more interested in cases where the speaker hopes the metaphor takes on a life of its own…and has an idea of what he wants to accomplish by using the metaphor. For example, Howard Dean is always introduced as Dr. Dean now. He’s a Doctor, sure. But isn’t it really designed to make him sound smarter than George Bush, whom everyone “knows” is dumb? Or take the attempted compromising of the term “Weapons of Mass Destruction,” (this was before the war…since then the use of WMD has taken on a whole new used to taunt the Bushies). Before the war, when the idea that Iraq might have (or still has) WMDs, a lot of anti-war folks tried to take the word out of its geopolitical context in order to rob the issue of the urgency the public seemed to be treating it with. You can call it subtraction by addition. The more you make it mean, the less people will remember its original meaning. “Poverty is a weapon of mass destruction.” “Crime is a weapon of mass destruction”. “Hate is a weapon of mass destruction.” “Ignorance is a weapon of mass destruction.” Rhetorically…what’s getting accomplished? You’re trying to rob the metaphor of its original meaning. Sometimes you can compromise an existing phrase. And sometimes you can introduce a new one. But what you’re really competing for is a spot in someone’s brain for your idea…and you want YOUR idea to be the default idea which all others have to challenge. You were doing this, although in a subtle way, by ending your e-mail with an exhortation to an “honest skepticism” of the “wonders” of the invisible hand being “sound.” Who doesn’t want to be honestly skeptical? It’s a sound policy. Isn’t it? And your formulation makes us suspect that even before we’ve even heard what it really means, we OUGHT to be skeptical. That it's something deserving of suspicion. That it's…well… suspect. There's been a crime. An injustice! The invisible hand did it!! I suspect you’re doing this not because you’re honestly skeptical of Adam Smith. I suspect you of wanting to appear reasonable in trashing an idea you’ve already decided you don’t like. You know the idea already occupies a space in OUR mind. And you want that space because you don’t like that idea. In fact, you’re probably a little mad at the phrase “invisible hand.” I’m guessing, but I’m guessing you probably think an unthinking public has been deliberately or at least unjustly deluded into thinking the invisible hand is a GOOD thing when you know, of course, that it’s not. If only we were more honest in our skepticism, we might expose this unjust charade for what it is. That seems sound. Your next question: How often do we lazily embrace such "idea packets" into our thinking without making the effort to examine their concepts ourselves? All the time. Take the word “capitalism,” for example. Marx invented it. Not Adam Smith. Marx invented it satisfy the self-imposed rigors of dialectical materialism which he had just invented. He needed a foil for Marxism. He had a thesis and he had a synthesis all ready to go. What he needed was an antithesis. And lacking one in the real world, he made one up. In fact, Marx was an expert at creating a whole vocabulary which treated ideas as if they were facts, when, in fact, they never were, or have been. To quote from an article by David Pryce-Jones in the New Criterion, Marxist abstractions are based on words like “bourgeoisie and the proletariat and the supposedly pre-ordained class struggle between them, capital and capitalism, empire and imperialism.” These abstractions are “the Marxist organizing principles which reduce human beings and their varied lives to concepts handy to serve a thesis worked up in advance and in the library.” Reducing human beings to classes and abstractions in the context of a great dream of history makes it easier to justify mass murder, by the way. But there’s a lot going on in the Marxist effort to “define” a world into existence. What’s that we say? The first step in characterization is appellation? And what’s the first thing you do in a debate? Define your terms. Make them argue on your terms, not yours. Marxism/Socialism has done this exceedingly well, partly because it appeals to the idea that it’s rational and that those who hold Marxist/Socialist ideas are intellectually superior, not to mention on the right side of history. Basing your argument in an appeal to intellectual authority has some other distinct advantages. First, since it’s so academic and theoretical, it intimidates a lot of people into either not disagreeing because they don’t understand these terms, or giving the terms some kind of authority because they are spoken by someone who pretends to be smarter. If you accomplish either one of these as a rhetorician, you’ve been successful, but only inasmuch as you’ve taken by language-bullying what you couldn’t persuade someone of. That’s how you get people saying all the time, “Marxism is fine in theory. It just breaks down in practice.” Well, in theory, when you want to invent a new man (who by the way doesn't exist and never has, but you would very much like all of us to become), and the old ones aren’t living up to your ideal standard, you round them up in Gulags and kill 20 million of them. Or sometimes you just starve them all to death. In theory, you’re creating a better world. In theory, that’s the course of history. In theory, that’s the sacrifice an individual must make…not just his individuality, but his life. From each according to his ability to each according to his needs... It works just as well, this theoretical crystal palace building, if you’re a member of the master race. Those who aren’t part of the Volk or the Vaterland don’t fit. They can be liquidated. In fact, they probably SHOULD be. Right? That sounds…sound. Doesn’t it? Marx’s understanding of political economy was based on a theory that there was such a class as the proletariat and that the only possession they had (Marx seeing the world purely in material terms) was their labor, which they had to sell to capitalists, who owned “the means of production.” Thus, two classes. Throw in the idea, and only an idea which is both unprovable and unknowable, that history moves in a straight line and ends somewhere, and you have a perfectly rational but totally bogus point of theoretical departure, which justifies nearly any incursion into individual liberty. “History is a system moving toward perfection and because there are two classes, one who is oppressed and one the oppressor. All political action must be dedicated toward overthrowing the oppressor, by any means necessary.” As an aside, even the idea that history is linear and moving toward some predetermined end where our choice doesn’t matter conceals a conceit that the world is a) ordered, and b) has an orderer who is man (because Marx was an atheist) and c) is in need of orderers and d) that the best orderer is he who understands the inevitability of history’s course. Of course, the workers of the world never united. They did not see themselves as “the proletariat.” They saw themselves as Germans, Englishmen, Frenchman, and Russians. And shortly thereafter, they marched off to war to slaughter each other in the millions for “France,” “the Motherland,” or “the Fatherland.” Note, all are abstractions…all metaphors…all horribly abused to inflict massive suffering on people…just as Marxism has. By contrast, Smith’s metaphor is both theoretically and intellectually benign, if not beneficent. It’s based on the idea that for the most part, people naturally cooperate…that there is, to use the Austrian Economist Friedrich Hayek’s term, an “extended order of cooperation” in which people benefit each other without even doing so knowingly. This rankles the intellectual because it suggests there can be order without an orderer. That the hand of Adam Smith isn’t the coercive hand of the State at all but the internal motive, maybe moral, maybe not, which pushes us to find mutually beneficial relationships more often than not. In fact, the more I think about it, the more I like Smith’s metaphor for the degree of choice it imputes to our actions and the goodwill, or at least good effects, that it suggests characterize our action. Wonders, indeed. I like the sound of that. By the way, here’s the full quote from Smith: But the annual revenue of every society is always precisely equal to the exchangeable value of the whole annual produce of its industry, or rather is precisely the same thing with that exchangeable value. As every individual, therefore, endeavours as much as he can both to employ his capital in the support of domestic industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. By preferring the support of domestic to that of foreign industry, he intends only his own security; and by directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention. Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good. It is an affectation, indeed, not very common among merchants, and very few words need be employed in dissuading them from it.

Maneuverability versus Firepower, a reader responds

Already getting a lot of feedback on previous posts. Like I said, I'll try and add a feature that lets you contribute feedback directly under the post. But for now, I'll post the interesting stuff here. By the way, I'm not AGAINST the Stryker program, nor am I really FOR it. I'm interested in it, and force transformation in the Army, as a geopolitical phenomenon that, I believe will make limited wars like Panama a lot more likely. We have an Administration that views the world in black and white, and is convinced of the need to fight terrorism wherever it finds it. Look at this quote from yesterday: "No nation can be neutral in the struggle between civilization and chaos. Every nation that stands on the side of freedom and the value of human life must condemn terrorism and act against the few who would destroy the hopes of the many." This was Bush yesterday at the American Legion. So far, the chaos that is France has escaped retaliation. But in all seriousness, as investors, its important to realize that Bush Administration is willing to use the military to fight this war. For the military to fight it and win it, it has to get more mobile without trading mobility for firepower. Or trading the security of armor for mobility. We'll see soon enough how well it does. And over time, we'll see how the rapidly deployable, highly lethal Stryker Brigades affect the stability of investment markets. If Bush is right and it really is us against them and we can go find them faster wherever they are and kill them, then the Stryker Brigades will be the midwives of the post-radical Islam world. If he's wrong...we'll see. Meanwhile, this interesting post from a reader: "There are plenty of observers touching on the ongoing debate over the survivability, lethality, and mobility of the new wheeled vehicles. Of course, it will be less survivable, but it will likely produce greater overall lethality through better maneuverability. If this sounds counterintuitive, you should see the opposition forces at NTC and CMTC, using mostly old but quick M113As, running circles around and handily defeating squadrons of M1As and Bradleys. Most Cav troopers don't like the changes, but they will get used to it, and the Army has been rewriting the doctrine for the last 4-5 years in order to adapt. And they'll fix the C130 deployability issue , that's not a real obstacle. But you're missing the deeper issue. And it's ironic, because the real reasons for the changes are economic: 1) Common platform. The real benefit of the Stryker Brigade is that all vehicle systems will (finally) be based on the same chassis. Consider a traditional Cav squadron with all kinds of different systems to deal with: M1A1, M3, M88, M113, M577, HMMWV, HEMMT --- all those vehicle systems require different parts to fix them, and none of them are interchangeable. Do you realize how many parts a maintenance team has to hump around the battlefield to fix all that stuff? And it's expensive, too. Budgets for repair parts constitute the highest annual costs for mechanized divisions (more than ammo, in fact, they usually run out of money for training ammo b/c they spend so much on repair parts); a lot of that cost comes from having to purchase so many different parts for different vehicle platforms. 2) We spend too much on turbine engines. An M1A1 power pack costs about $130,000 a pop. If you have to put it together first, it takes about 8 hours to install, and if you get just a little bit of dirt inside it, it blows out when you start the engine. Then it has to be taken out and rebuilt in a contained, dust free environment. Battlefields are dirty. You cannot fix an M1 forward with a whole lot of reliability. Units burn through a heck of a lot of $130K engines, probably a few a day for a battalion. Conversely, a blood and guts diesel engine is a lot easier to fix in any environment, with greater reliability and significantly less cost. 3) Training mechanics. The Army spends a lot of money training a lot of different types of mechanics. It takes 2 different types of mechanics per armored vehicle (hull and turret). Unfortunately, that 63E only knows about the M1A1 engine, he can't even replace a starter in a HMMWV. If there are no M1As to fix (which is rare), he sits idle. And this is the same across the vehicles systems. Except for 63B wheeled vehicle mechanics. They can fix HMMWV’s, HEMMTs, 5-tons, any wheeled vehicle. And the Stryker brigade mechanic will be even more flexible. He'll be able to fix any vehicle in the fleet. Sure, there will still be some specializations for missile systems, etc, but for the most part the Army will save big money on training and maintaining the ranks of mechanics. 4) Can't train with tracks. The biggest problem with heavy tracked vehicles is back home ... you can't get them out of the motor pool. The Army can't just drive its tracked vehicles down the road to the training area. A 65-ton M1A1 rips up the concrete beneath it and destroys roads. That means if you want to go train (a unit's lifeblood and sole purpose in life), you have to load up all your vehicles on a train, there and back. That's what they do in Germany, where the Deutsche Bahn literally and freely dictates its own price, rules, and availability to the U.S. Army, even when they are deploying. In the U.S. we got sick of railing everything out to NTC, so we bought a whole fleet of vehicles for units to train on out there. That means a unit rarely gets to train (other than gunnery) on its own vehicles. That also means less training opportunities because everybody's competing for the same static training area. But the Stryker brigades will just roll out the back gate (or down the autobahn) to train at will in local training areas. That means more training at lower levels, for a lot less money. In the end, an economically lighter and more efficient force will translate into an even better trained and capable force. Readiness will increase significantly, as well as the ability to deploy and fight rapidly. This evolution is great for our Army (and outstanding for our tax dollars). Regards, (I've withheld the name) P.S. There's a lot more to that Chechnya armored column example, widely studied in our US Army professional development seminars, particularly by CAV and Armor officers. If you knew the whole story (the way they got suckered into parking a column in an urban area in the first place), you'd realize their gruesome defeat had very little to do with how thick there armor was. DENNING COMMENT: IF OUR FORCE IS BETTER TRAINED, MORE CAPABLE, AND CAN DEPLOY AND FIGHT MORE RAPIDLY IT'S OBVIOUSLY GOOD FOR THE ARMY. BUT IT ALSO MAKES IT MORE LIKELY THAT WHOVER IS COMMANDING THAT ARMY (BUSH OR HOWARD DEAN) IS GOING TO USE IT MORE OFTEN. AND THAT BRINGS US ONE STEP CLOSER TO BEING THE WARFARE STATE I'M WORRIED ABOUT.

Let's Play Find the Fundamentals

You're not supposed to get emotionally attached to your trades. And I'm not. But I did establish a put position in a major semi-conductor index in my options service yesterday. Seeing the kind of pablum below is a little aggravating...more so than normal. Here's the quote, courtesy of " Harris Nesbitt raises chip sector rating to 'positive' ($SOX, BRCM, IRF, MCHP, TQNT, RFMD, SWKS) by Tomi Kilgore NEW YORK (CBS.MW) - Analyst Ambrish Srivastava at Harris Nesbitt Gerard raised his rating on the semiconductor sector to 'positive' amid growing confidence in the continued improvement in industry fundamentals. Srivastava believes that besides all the positive macroeconomic data, increases in average chip selling prices have been holding, suggesting the 'relentless' erosion in prices may have finally ended. Among individual companies, Srivastava upgraded Broadcom (BRCM), International Rectifier (IRF) and Microchip Technology (MCHP) to 'outperform' from 'neutral,' and RF Micro Devices (RFMD), TriQuint Semiconductor (TQNT) and Skyworks Solutions (SWKS) to 'neutral' from 'underperform.' The Phlx Semiconductor Index ($SOX) tacked on 0.6 percent despite losses in the broad market. " What positive macroeconomic data? How has the erosion in chip prices possible again? This in a world of massive productive overcapacity? Where's the evidence that final demand for chips is picking up? Hmm...maybe it's there. But it sure as heck isn't proven in this kind of article. Remind me of what the difference is between this and flat out stock promotion...

Gold Traders Up Their Net Long Position by 35% in One Week

O la they say here in France. The latest commitment of traders report from the Commodity Futures trading Commission shows that large scale speculators added 61 tonnes to their position in the last week. Shorts reduced their position by 12 tonnes for a net gain of 73 tonnes, or 35%. What have we here? Are gold speculators getting ready for another geopolitical bomb to go off? Are they spooked by the collapse in the bond market and taking the current stock rally as a chance to exit equities and get into gold? And what to make of the hedged majors who keep reducing their forward short sales. Looks to me like a whole lot of folks are tying their lifelines to gold and getting ready for a firestorm in the credit and currency markets. Then again, this could be gold speculators getting over eager. However I suspect what you're seeing is a realization that derivatives contracts based on mortgage backed securities or even the U.S. Treasury markets itself are falling out of favor as a way to hedge against a risk. With the GSEs (Fannie and Freddie) rocked all summer by internal problems that still haven't been fully disclosed, no one wants to be a counterparty to a risk that's getting increasingly dangerous. Gold, on the other hand, at least the physical kind, is no one else's promise to pay. It doesn't represent a debt or an obligation. And that's why it's a reliable source of value when paper gets crumpled. There is an irony, of course, that speculators are looking to make money in the gold derivatives market based on gold' standing as a real, tangible store of wealth. But for investors wondering if and when Wall Street as an institution is going to be scared enough of Fannie and Freddie to get behind gold, the huge increase in net long gold is an encouraging sign.

Program Trading and Plunge Protection

Did some pinch-hitting for the Daily Reckoning this morning and wrote the notes that normally come from Eric Fry. Some of what you see here you may also see in the DR. But the nice thing about publishing here is that I can show you some pictures to go along with the story. So that's what I'll do.... If you're reading this kind of information, odds are that at some point you've heard of the "Plunge Protection Team" or PPT. The PPT, the conspiracy goes, is a the active arm of the President's Working Group on Financial Markets. The Working Group was formed by executive order in 1988 during Ronald Reagan's first term. After the 1987 crash, its goals were to "[enhance] the integrity, efficiency, orderliness, and competitiveness of our Nation's financial markets and [maintain] investor confidence." The order goes on to say that, "To the extent permitted by law and subject to the availability of funds therefore, the Department of the Treasury shall provide the Working Group with such administrative and support services as may be necessary for the performance of its functions." No where in the order does it say the Working Group is responsible for causing stock market rallies late in the day to soothe a jittery public and keep the politicians happy. But I guess you wouldn't expect to find that in the print...even the fine print. Still, the existence of the PPT is one way to explain how you can reverse an entire day of selling on the Dow by buying futures contracts on the big indexes during the last two trading hours of the day. Suddenly, what looks like an 81-point loss and getting worse is a modest 22.81-point gain--and within striking distance of the 14-month high the Dow set last week. More on the PPT below. Maestro Greenspan and his merry men COULD orchestrate a reversal by buying an enormous amount of S&P or Dow futures contracts late in the day. How would it work? The easiest way would be to buy front-month futures contracts on the S&P and increase the spread between the futures market and the cash index. The spread is the difference between the fair value of the cash index and what the futures market is pricing the index at. By buying S&P futures, you increase the "spread" between the futures market and the actual cash index. And if the spread gets big enough, program trading kicks in to buy the cash index rather than the futures. Could you prove this is happening? Well, you could look at prices for front month futures contracts on the Dow and S&P and see what kind of buying took place between, say, 1:00 p.m. and 2:00 p.m. yesterday. If you looked at the front-month DJIA composite here's what you'd find: Dow Futures Rising What does this show you? Well...I'm not a futures expert. And I'm not sure if this necessarilyily the right contract to look at. But it looks to me like a little after 1 p.m., there was a whole lot of buying in the front month Dow futures contract. And what happened to the Dow itself after 1 p.m.? Take a look.... Interestinging, no? Was this just the market shaking off the bad news and looking on the sunny side of life? Or did the futures buying trigger buying on the cash index? To answer that, you could check to see what the program trading statistics were for the day in question. The Wall Street Journal publishes program trading stats on a weekly basis. And according to the Journal, in the last four weeks starting on July 25th, program trading has accounted for 38.5%, 42%, 45.5%, and 39.9% of the total trading volume for the NYSE. The August 22nd Journal reports that for all the program trades on the NYSE during the week ended August 15th, "13.6% involved stock-index arbitrage" and that "Some 53.9% of program trading was executed by firms for their clients." Is Uncle Sam a client? And is he pumping money to accounts set up with the big brokers on Wall Street to buy futures and cause program trades to kick in and buy the cash index? I report, you surmise.

August 26, 2003

Future Combat Systems Could Be Worse Than Present Combat Systems

The Army wants to get lighter and more lethal at the same time. It's solution has been the formation of Stryker brigades--about 5,000 men equipped in a variety of wheeled vehicles that can deploy aboard C-130 transport planes anywhere in the world in less than 4 days. But already there's a question about whether the Stryker's have enough armor and whether or not they can be as easily transported as the Army says. Take a look at this quote from an article in today's Washington Times "As part of an accelerated development, the Army did not require Strykers to immediately feature anti-RPG armor. The brigade going to Iraq is now being fitted with slat armor. It works like a big catcher's mask, stopping a grenade before it reaches the Stryker's main body, thus keeping the explosion at a distance. Eventually, the Strykers will be fitted with more permanent armor now being tested." The Army says "The Stryker has successfully passed live-fire tests against rifle and machine-gun fire. The slat armor system has also shown in tests that it protects against grenade blasts." But a report circulating on Capitol Hill by consultant Victor O'Reilly makes competing conclusions. Here are three: •Poorly armored and entirely vulnerable to RPGs. •Wheels & wells extremely vulnerable to small arms. •Bought to be C-130 deployable but too heavy. We'll find out soon enough. The trouble in the "Sunni Triangle" of Iraq is exactly the stype the Stryker Brigades we're conceived to handle. They'll be operating in hunt and chase mode, finding the enemy, closing with him in combat, or "fixing" him for targeting from artillery and air strikes. But if the Stryker is as vulnerable as critics suggest, it's going to make things in Iraq worse, not better. Here's what the Russian's were using in Chechnya. It's faster. It's also more vulnerable, especially in close quarters: And here's a Styker unloading in close-quarters from a C-130, courtesy of the Air Force: By the way, if you want to reach an interesting account of Russian operations in Chechnya, which depended heavily on the use of wheeled personnel carriers with similar armaments like the Strykers', look at this Rand Corporation report: . It contains some amazing details about Russian operational planning for the Russian's first invasion of Chechyna, including one where an entire Russian column was blocked from getting to Chechyna by a local automarket in Russia where some 8,000 people gathered regularly on Saturday's to buy and sell cars. It's not really a laughing matter, of course. Presuambly, the Army knows the dangers of using even fast moving armored columns in hostile areas. For one they've just had a lot of experience doing it. And second, one of their own, Major Ricky J. Nussio, in a monograph titled "Tanks in the Street, Lessons Learned Through Bytes Not Blood," quotes a book about the war in Chechnya which offers the following stark image about an armored relief column: "According to the participants in the battle, a grenade launcher antitank shell then knocked out the column's command vehicle and the column lost any effective command. The tank immediately lit up like a torch...Each of the group's armored personnel carriers were pierced by at least five anttank grenades..." So which will it be? The Next Generation U.S. Army? Or the Last Generation Russian Army?

Clear as Muddle

Consumer sentiment improves, but sales of new homes slow down. Durable goods orders are up, but stocks are falling. Is this more muddle? Or can we make something of it? This from "The Conference Board said its monthly gauge of consumer sentiment improved robustly in August as Americans pinned their hopes on brighter economic times ahead. Meanwhile, the Commerce Department reported that new-home sales dipped in July as rising mortgage rates turned off some house hunters. But even with the decline, sales posted their second best month on record. Earlier, the government announced that orders for durable goods -- big ticket items like refrigerators, designed to last three years or more -- climbed 1.0 percent in July after a rise of 2.6 percent the previous month. The report was broadly in line with economic analysts' expectations." Let's deal with the confidence numbers first. Consumer confidence is now 32% higher than it was in March. But what exactly does that mean? Does it mean consumers are 32% more likely to buy houses? Or 32% more likely to buy a new refrigerator, take a loan, start a business, or buy stocks? It doesn't mean anything, to be honest. The best expression of consumer confidence is consumer spending. A confident (often falsely) consumer is a spending consumer. So what to make of the durable goods report? Durable goods orders rose 1.0% in July. Strip out defense capital goods and the growth rises to 1.4%. This is still 53% lower than June's growth rate of 2.6% Orders for primary metals, computers, and machinery were all up nearly 2% in July. But upon closer look, investment in non-defense and non aircraft goods was up only .4% after being up 2.1% in June and 1% in May. What does this tell us? This is not the robust pickup in business investment we've been told about. And even in the areas where you ARE seeing growth in business spending (computers and electronics), it's not the kind of capital investment that creates jobs. It's true, investment in computers and electronics may lead to productivity gains. But that's just another way of saying investment in labor saving machines leads to higher unemployment. It would be all well and good if every job lost to a computer or a machine was replaced by one in a new industry. But that's not the case. The American economy is NOT doing a good job at replacing the jobs it loses to higher productivity with other jobs. The end result is a structural change in the labor market where those with the skills and the jobs do more work for, perhaps, a higher wage. But the rest are left unemployed or underemployed or working at Wal-Mart and McDonald's. And if you want to make the argument that we'll get through it because we're more "dynamic," that's fine. But faith in American dynamism does not create jobs are give America a competitive advantage at producing anything. Investment creates jobs. And you invest in industries which are profitable because you have some advantage over others. In today's American economy, it's not clear what future industry is going to emerge to give America a competitive advantage...AND absorb the large poll of available labor at the wage levels all those laid off manufacturing workers are used to. If you have an answer, let me know.

Move Up Trailing Stops in ADG and DCO

In last week's weekly issue, I advised you put a 15% trailing stop in two of our defense stock positions, Allied Defense Group (ADG) and Ducommun (DCO). Move them up again. Incidentally, the capital goods sector of the market has been strong in the last half year. GE is up 27%. John Deere is up 34%. And even Tyco has come on nicely to rise 34%. The notable exceptions have been major aerospace/military companies. Lockheed Martin is up only 9.6% in the last half year. And Northrop Grumman is up only 7.12% Investors trying to make money off the new American way of war are going to have to look at mid-cap and small-cap stocks. I've stuck with the mid-caps in our portfolio. You still have liquidity with them as an investor. But the business you're buying is far more responsive to increased orders via new defense contracts. Chalk it up to the division of labor. When a smaller company like Allied Defense Group gets a new contract from a military, it makes up a larger part of its net sales and net income. For example, when ADG's Belgian subsidiary announced at $28.4 million contract in may to supply the U.S. Army with bunker busting 105mm rounds for its new Stryker assault vehicles, it wasn't just another throw away contract. It was a full 16% of ALL of ADGs sales for the last 12 months. Compare that with Boeing. Yesterday, the Defense Department announced that "The Boeing Satellite Systems Incorporated, El Segundo, Calif., is being awarded a $21,134,625 cost-plus fixed-fee contract to provide for design and delivery of space-qualifiable, open architecture on-board digital signal processor. " The contract is about the same size in dollar terms, give or take a few million. But as a percentage of Boeing's $51. billion in sales....$21 million is just another day at the office for Boeing.

Housing Stocks Topped Out Too?

The macro evidence of a housing top is below. But what is the market telling us? Well, it hasn't opened yet as I write this. But let's look at a micro example. This from Dow Jones Business Wires: "Toll Brothers Inc.'s fiscal third-quarter net income jumped 27% amid a surge in housing sales and record-level contracts. The luxury-home builder Tuesday reported net income of $68.2 million, or 90 cents a share, for the period ended July 31, compared with $53.5 million, or 70 cents a share, in the year-earlier period." That's good new for TOL. It managed to make money during the huge, blow-out rally in homebuilding and housing sales. Bravo! But with rising rates and a peak in home sales, where will the earnings come from? You don't have to be a chartist to see look at this and see a massive long-term top in home-building stocks. And if you don't want to go visit the chart, don't worry. It shows four top home-building stocks, Centex (CTX), Lennar (LEN), Ryland (RYL), and Toll Brothers (TOL), enjoying a huge run up in mid 2002 before the summer crash...and then another huge run up beginning with the end of major combat operations in Iraq. Looks like another peak to me...and a good time to be "short" homebuilders through puts on the Philadelphia Home Building Index (HGX). That's exactly what I'm doing at Strategic Options Alert. I'll keep you posted on how we do.

If it Looks Like a Peak and Acts like Peak...

Suddenly, I'm getting a lot more questions about just why I'm bearish on housing. Two charts below show why, in graphic terms. But let's not forget the root cause of the mortgage bubble, loose money. The Fed has spawned a series of bubbles, first in the Nasdaq, later in the bond market, and all along in housing. The only question now is, "When rising long-term rates are going to slow the growth in both prices and purchases?" My prediction? Yesterday's reported record growth in existing home sales for July reflected a last rush to lock in low rates that had already begun rising by late July. But don't take my word for it...look at the charts, courtesy of the excellent researchers at SIX MILLION HOME BUYERS GET IN AT THE TOP... AND MANAGE TO LOCK IN THE FASTEST GROWTH IN PRICES 14 YEARS.

Nobody Notices...

...that even while the stock market has set new 14-month highs in the last month, gold has actually been doing a lot better. Here's the proof...courtesty of

Weekend at Verdun

Since I read The Price of Glory by Alistair Horne (see right) three years ago, I've wanted to visit Verdun. It was the site of one of the most memorable, if not deadly, battles for World War One. Hard to imagine that less than 90 years ago this kind of French country side was transformed into this. I went this weekend with some friends from here in the Paris office. It was sobering, mystifying, and a little frightening. By far the most grim part of the trip was the visit to the ossuary. According to Webster's, an ossuar is a, "L. ossuarium, fr. ossuarius of or bones, fr. os, ossis, bone: cf. F. ossuaire.] A place where the bones of the dead are deposited; a charnel house." That's about right. . The best quote I've ever seen about how Europe could have fallen so head-long into madness is from F. Scott Fitzgerald's book, Tender is the Night. "See that little stream--we could walk to it in two minutes. It took the British a month to walk to it--a whole empire walking very slowly, dying in front and pushing forward behind. And another empire walked very slowly backward a few inches a day, leaving the dead like a million bloody rugs. No Europeans will ever do that again in this generation." "Why, they've only just quit over in Turkey," said Abe. "And in Morocco--" "That's different. This Western Front business couldn't be done again, not for a long time. The young men think they could do it but they couldn't. They could fight the First Marne again but not this. This took religion and years of plenty and tremendous sureties and the exact relation that existed between the classes. The Russians and Italians weren't any good on this front. You had to have a whole-souled sentimental equipment going back further than you could remember. You had to remember Christmas, and postcards of the Crown Prince and his fianc�e, and little caf�s in Valence and beer gardens in Unter den Linden and weddings at the maire, and going to the Derby, and your grandfather's whiskers." "General Grant invented this kind of battle at Petersburg in sixty-five." "No, he didn't--he just invented mass butchery. This kind of battle was invented by Lewis Carroll and Jules Verne and whoever wrote 'Undine,' and country deacons bowling and marraines in Marseilles and girls seduced in the back lanes of W�rttemberg and Westphalia. Why, this was a love battle--there was a century of middle-class love spent here. This was the last love battle." On the bright side, we had an excellent dinner at a restaurant called l'Apostrophe at 59, place Drouet d�Erlon in Rheims the night before. If you get to Rheims, a visit to the Cathedral there is worth your time. It's only an hour or so from Paris. And the stained glass windows behind the altar were done by Marc Chagall. A much nicer picture...

The Politics of Comparative Stupidity

The Howard Dean quote below is one reason why a trade war is highly likely in the next administration--whether it's Bush, Dean, Gephardt, or Hillary Clinton. Free trade is always a convenient political scapegoat. You don't gain much ground trying to explain to voters that allowing inefficient or uncompetitive industries to go the way of the dodo makes an economy richer, not poorer. All the voters hear--and all the politicians are willing to talk about--are lost jobs as a result of "unfair trade." Take Bush and steel, for example. The Mackinac Center for Public Policy reports that the Bush steel tariffs cost 8 jobs for every one steel job preserved. It also estimates that higher prices for steel would actually decrease U.S. nationa income from between $500 million and $1.4 billion. And even in the places where the steel tariffs are supposed to preserve jobs, they do more harm than good. Mackinac says that Michigan stands to lose more jobs in steel-related industries than every state in the Union except California. What's more, Michigan stands to lose almost five jobs in steel consuming industries for ever job saved in the steel producing industry. Here's the rub: trying to protect jobs with tariffs only costs jobs. It raises the price of the goods protected by forcing consumer to pay more for the product than they would otherwise have to. Forced to pay more for the product (either through subsidies/taxes) or higher prices, both consumers and businesses are prevented from spending or investing that money in ways that would create new jobs and add income and actually grow the economy. There's nothing new here. It's just basic economics. Under the Law of Comparative advantage, you produce what your most efficient at producing at the lowest cost and you trade that for the production of other low cost producers. If it really did work that way, consumers would get better and cheaper products and jobs would be created and incomes would rise. It DOESN'T work that way because of tariffs. And tariffs are largely the product of self-destructive nation states and politicians which want to blame economic stagnation on foreign competition rather than on poor public policy. What you eventually get is what we're starting to see now. "Blame the Foreigner." "Make the Chinese Pay." "Fair Trade, not Free Trade." Denning Forecast: The trade wars are coming. And when they do, the shooting wars may not be far behind. Defining Dean ( "One multilateral institution that might not fare so well in a Dean administration, though, is the World Trade Organization. In what would be a radical departure, China and other countries could get trade deals with the United States only if they adopted 'the same labor laws and labor standards and environmental standards' as the United States. Whether or not that demand was consistent with WTO rules? 'That's right.' With no concession to their relative level of development? 'Why should there be? They have the right to have a middle class same as everyone else.' Dean says, 'We've tried it' -- NAFTA, WTO -- 'for 10 years, and has it succeeded? No. . . . What's the purpose of trade? If it's to create jobs, we haven't done that in America.'

The New Great Game?

The Canadian columnist Mark Steyn has a provocative take on the U.N. bombing in Baghdad here: Here's the key graph: "And so on Tuesday, up against an enemy unable to do anything more than self-detonate outside an unprotected facility and take a few Brazilian civil servants and Canadian aid workers with him, the global community sent out a Syrian ambassador to read out some boilerplate and then retreated into passivity and introspection and finger-pointing at Washington. This is the weirdly uneven playing field on which the great game is now fought. Islamic terrorism is militarily weak but ideologically confident. The West is militarily strong but ideologically insecure. We don't really believe we can win, not in the long run. The suicide bomber is a symbol of weakness, of a culture so comprehensively failed that what ought to be its greatest resource--its people--is instead as disposable as a firecracker. But in our self-doubt the enemy's weakness becomes his strength. We simply can't comprehend a man like Raed Abdel Mask, pictured in the press last week with a big smile, a check shirt and two cute little moppets, a boy and a girl, in his arms. His wife is five months pregnant with their third child. On Tuesday night, big smiling Raed strapped an 11-pound bomb packed with nails and shrapnel to his chest and boarded the No. 2 bus in Jerusalem."

August 25, 2003

Land of the Free, Homeland of the Government

The Pittsburgh Post Gazette reports that the new Department of Homeland Security has 1 in 12 federal employees. But wait, there's more: WASHINGTON -- The six-month-old Department of Homeland Security has 40 percent of its 160,000 employees working as "watchers" at airports at average salaries of $29,000 but also pays 324 funeral directors, 128 pharmacists, 55 general anthropologists, 41 fingerprint specialists and 30 chaplains. In the first public examination of the makeup of the new department, which constituted the largest reorganization of government since World War II, a research group at Syracuse University found that the fledgling bureaucracy already has at least one full-time employee in one of every five of the nation's 3,146 counties. The Transactional Records Access Clearinghouse (TRAC), a data gathering, data research and data distribution project at Syracuse, said that DHS, one of 15 Cabinet-level departments, now employs one of every 12 workers in the federal government. Denning Comment: Maybe DHS can start hiring all the folks who've been laid off from America's factories. America's new competitive advantage: bureaucracy. And you thought it was just France who had a large civil service. Meet the U.S. Government, the France of the 21st Century. The article is hosted on the subscriber's portion of the Financial Times site. Here's the important graph: Instead of cutting 30,000 civil service jobs by replacing one in two retiring at the end of the year, Mr Raffarin is drawing up a more cautious replacement policy. As he prepares the final guidelines this week for presentation of the 2004 budget in September, officials indicated the total number of jobs cut was likely to be about 5,000, in a country where almost one in four people in work are state or para-state employees.

An Unblinking Eye, or the Eye of Sauron?

(The Eye of the Homeland, coming to a neighborhood near you...) The military has promised us that the use of unmanned aerial vehicles in a "battlespace" gives friendly forces an unblinking eye with which to constantly survey events on the ground and gater intelligence. Of course there's no reason that the same technology can't be hovering above U.S. airpace as well, is there? Well...the only reason is that the FAA, up until now, has been worried about dozens of UAVs in the air colliding with civillian aircraft that ARE manned, sometimes with hundreds of people. But this articles from the New Scientist reports that, "The US Air Force's Global Hawk became the first pilotless aeroplane to be given permission to fly routinely in civilian airspace on Thursday. The article continues, "The US Federal Aviation Administration issued the USAF and Northrop Grumman, who make the jet plane, a certificate of authorisation (COA) allowing the RQ-4 Global Hawk to enter national airspace with almost as much ease as a piloted plane." More on this story with my full report on UAVs and the transformation of the American military. The key point, of course, is that this is not just a development with military implications. It represents the militarization of American society. The War on Terror is constant, as it's been sold to the public. And thus, our vigilance must be constant. Welcome to the surveillance society.

Away Land, or Never Never Land?

As big a critic as I am of the "us" and "them" categories the Bush admininstration is fond of using, sometimes the French are even more absurd at distorting reality. France, or "awayland" as I've taken to calling it (as opposed to the "homeland") has recently told Israel that it believes there is no evidence that Hamas and Islamic Jihad are ''terror groups.'' The website reports that the diplomatic advisor to Iraq, one Messr. Maurice Gourdalt-Montagne told the Israeli ambassador in France, Nissim Zvilli, that France is not convinced Hamas and Islamic Jihad are "terror" groups. In the article here, the Frenchman says: "'If we find that Hamas and Islamic Jihad are indeed terror groups opposed to peace, we may have to change the EU's stand,' Gordo conveyed. 'However, we mustn't limit ourselves to one, clear cut, position.' " You'd think statements like the one below, might convince the French that limiting onself to a "clear cut" position is often known as "recognizing reality." "I swear we will not leave one Jew in Palestine," he (Mahmoud Zahar, a Hamas leader) said. "We will fight them with our might." Hamas is the largest militant group carrying out bombings and shootings against Israelis. In more than 90 suicide attacks since September 2000 ---- most by Hamas ---- more than 350 people have been killed. Or, the French could take a look at the quotes of children like 12-year old Yehia Dass, who marched in a protest this summer. Even though the boy's father is impriosned by the'd think this kind of thing coming from children educated in Palestinian schools, funded by Palestinian charities, would wel...make it a little more clear cut for the French. "We must continue to kill Jews until our land is freed," he said, as the procession marched from Unknown Soldier Square in downtown Gaza City to the offices of the International Committee of the Red Cross (ICRC). "After the three-month truce is over, we will resume killing them because they want to kill us too and there is no other way," he added in a defiant tone.

25 dead, 150 injured in Bombay blasts

This is more than a little disturbing. In the September issue of Strategic Investment, I reported that three containers of cobalt-60 were stolen from a steel factory in Jamshedpur, India. You can see from this map that Jamshedpur is on the eastern side of the country while is on the opposite side next to the Arabian sea. Doesn't really matter though, does it? Next time, it COULD be a dirty bomb. And next time (there will be a next time) it could have more destabisling effects on financial markets (see below), especially if it happens in say, Tokyo, Sydney, or Riyadh. Why India this time? First, this is happening in India and not Indiana largely because the real struggle now for radical Islamists is to prevent their own cultures from accepting modern values. Destroying your own secular institutions does far more to sow chaos than destroying American buildings. Second, India is a microcosm of the big ideological struggle of our time: Islam vs. the Secular State. The separation of Muslim Pakistan from secular India never really solved the problem. India has 15 official languages. It's the world's largest democracy, in terms of population. Hindus, Muslims, Christians, Sikhs, and Buddhists live and work together. In some ways, you can see why it's a prime target for militant Islam. India is a test case for modernization without Westsernization. It seems like India is well on its way to becoming a pluralistic, thriving, market economy. You can see why Islamic terrorists find that prospect threatening. After all, if India can chose modernity and succeed despite its many ethnic challenges, it would prove to rest of Southwest and Southeast Asia that you can have modernity without having to accept American culture. Once that idea is an established fact (prosperity and secular government with the freedom to worship the way you want), it becomes very difficult to stop. Better to blow it to bits now, before it has time to mature and improve people's lives. And this isn't the first time either, according to the Star of Malaysia. "Earlier Monday, the government archaeological agency released a report on a religious site in the northern town of Ayodhya, claimed by both Hindus and Muslims. That dispute has been blamed for previous explosions in Bombay, including a series of bombings in 1993 that killed more than 250 people and injured 1,000. Police blamed Islamic militants. They said those blasts were in retaliation for the 1992 destruction by Hindu mobs of the 16th-century Ayodhya mosque, and to avenge Muslim deaths in riots that followed. Some Hindus claim the mosque was built centuries ago on the ruins of a Hindu temple that marked the birthplace of their supreme god, Rama" The Hindustan Times reports that "Share values virtually crashed on the country's leading bourses at mid-session after reports of blasts which rocked the business capital, driving the BSE index down by over 180 points, placing it at 3943.66. " Can stock markets ever fully price in this kind of thing? Some folks would say "yes." In fact, I recall hearing some people say the bear market would really be over by now if there wasn't a lingering terrorist threat--in essence that there's an unseen but constant ceiling on stock prices because of terrorism. But this kind of thinking implies that once the terrorist threat is licked, stocks will be untethered from geopolitical forces. And THAT is absolutely not true at all. The chief feature of the kind of terrorism that is now a permanent part of our lives is that it attacks the institutions of Western culture, not its armies. Going after the stock market in Mumbai is a lot easier than say, attacking an army base. And in the end, a lot more effective at achieving the ultimate end, which is to fracture the culture and clear the way for a small minority to impose its religious will on the majority.