September 12, 2003

Checking in From London

Alive and in London and on my way shortly to a meeting with Jim Bianco from Arbor Research. Jim usually has the inside skinny on the bond market, especially Fannie and Freddie. With Congress deciding to give the Treasury Department oversight responsibilities...we'll have to see how much, if anything, changes. And of course the big issue is system risk. Fannie and Feddie guarantee 45% of all mortgage debt in the U.S. If you're counting at home, that's a $7.1 trillion market...all backed by government guarantee. It's larger than the Treasury market...and on one really knows how well Fannie and Freddie are managing portfolio risk. Hopefully we'll find out before it's too late. Also met with the folks at the World Gold Council. Much of what was said was off the record. But suffice it to say the next few months could be huge for gold. Of course right now, there's an epic battle in the futures markets with commercial gold traders short the metal and large speculators long. The spot price was down yesterday, but it's defied the negative sentiment implied by the commercials. A big move--up or down--could be in the offing. More later today after my meeting. regards, dan

September 10, 2003

Whispers of a Nameless Wonder

Have just returned from hearing a speech by Hernando de Soto. De Soto was here in Paris today speaking to a small group of French academics about the important of title and private property in creating prosperity. He spoke in French, though. And my French is…err…un catastrophe. I’ll give you the full rundown on what I think was said tomorrow. For now, be thinking tonight of whether the idea of private property is a Western Liberal construct (a distinctive feature of a certain geographic place, Europe, at a certain time in history) OR…an essential element to ANY culture that hopes to raise standards of living. Discuss amongst yourselves. I’ll get back to it tomorrow. By the way, De Soto’s book is called “The Mystery of Capital.” I’ve linked to it on the right of the home page at Gag Reflex or Appetite? The market now resembles the fat man from the famous Monty Python skit. It is fully priced for good economic news--especially when there’s so much bad geopolitical news. But it is salivating at the prospect of a third quarter with 5%-6% growth. That’s Chinese-like growth, and you could forgive the market for rallying on the rumor and selling on the news. It’s just too good of a whisper number to pass up. reports that: “Though it is early to be providing reliable estimates given the lack of information on even July inventories or trade, personal spending alone seems to guarantee a heady growth rate as the continued upturn in business investment and a likely turn higher in late quarter inventories will add on. Inventory rebuilding and the lift from business investment should improve labor market conditions markedly in Q4. The upturn in core inflation will wait for a few quarters of strong growth as underlying demand provides increased pricing power." It will be interesting to see if this whisper number was part of the rally we just saw, or will power this rally even higher. Today, however, the selling is broad based, taking down techs and golds alike. You could see this coming. And I tried to trade it in the most responsible way you can in a market so overvalued: by attacking the most speculative stocks with puts. I counted semi conductors as the most speculative stocks, simply because they almost always lead bullish rallies and drag the markets with them…until they get too far ahead and give back 5-6% in one day, like the SOX is doing. And then there’s the Semiconductor Holder Index (SMH) which I’ve had in my sights for the better part of a month. It pains me to see the index doing what it’s doing today--after our puts were stopped out. But there IS a silver lining here for traders. This index moves at extremes. It’s the right index to be bullish or bearish on at turning points. With options, you’ve got leverage. The critical question is timing. And if you control your risk, you can afford to be wrong, provided you’re right at least one big time. One big time…you get the feeling there are going to be lots of swings this fall that give you the opportunity to be right one big time. In gold. In semis. In small caps. In Treasury notes. In housing. In retail. I’ll keep you posted as I come across new ideas. An Idea Whose Time Has Come...

Someone Call the U.N.

The Economist is reporting that Germany and France are in violation of the EU's stability pact. Perhaps we need more U.S. troops on the ground in France. This bilateral adventurism must stop. GERMANY and France, so long the European Union’s head partnership, have become partners in crime. Last Friday, Germany confessed to the European Commission that its budget deficit for 2003 would breach the stability and growth pact for the second year running. The pact, a largely German creation, is meant to stop members of the euro area undermining the single currency through fiscal irresponsibility: countries are permitted to run deficits of no more than 3% of GDP. Germany admitted to a deficit of 3.5% last year and expects one of 3.8% this year. Not to be outdone, France on Monday owned up to a projected deficit of 4% this year, to follow a deficit of 3.1% last year. Of the two, Germany was the more repentant sinner. Hans Eichel, the German finance minister, insisted that he was still hoping to abide by the pact next year; Jean-Pierre Raffarin, the French prime minister, has already given up on that goal, according to Les Echos, a French newspaper. This is exactly the type of thing that will eventually make the euro every bit as dangerous as the dollar. In fact, there are few safe havens when it comes to paper money. Still, the fortunes of the dollar and the euro wax and wane, along with gold. Look for a strong dollar, not because of record U.S. debt, but because of stronger U.S. economic growth than in Europe, which announced yesterday it slipped into recession in the second quarter. Germany, France, Italy, and the Netherlands all saw growth reverse in the second quarter. This kind of news won't make the Swedes anxious to join the EMU when they vote in four days. And it's certainly not going to improve the chances of England joining the Euro in the next year. You'd think it would also be near-term negative for European stocks. However, the weaker euro boosts European some of the effect of negative GDP growth is offset by optimism over higher exports. Optimism like this is ultimately misplaced. Europe has chronic macro economic problems. It's being out consumed by the U.S., out produced by China, and out saved by Japan. I'm looking to trade on the euro zones weakness three ways. First...there's an iShare that targets the movement of the currency. Chart is below. Regrettably, no options trade on it. Next, the AMEX Euro top 100 Index. But for lack of liquidity, it would be a great proxy to be bullish or bearish the euro zone Then there's XEO, the S&P Euro 100 Index. Here, you haveliquidityy, and some reasonably priced options. SOA subscribers be on the lookout for getting in on this trade. The dollar dropped about 3.4% against the euro when U.S. GDP news broke. With euro zone GDP news so negative, the dollar is up against the euro in trading in London this morning. I think we're on an a path to parity, before the dollar standard gives up the ghost altogether. Meaning we may have a small window to be short the euro and make some profits.

Chinese Factories vs. the American Printing Press, Who Will Crack First?

My favorite image from the entire summer was Lance Armstrong getting back on his bike after crashing at the base of Luz Ardiden and obliterating his rivals. There's a great phrase for what happens to a rider when he can't keep up with the pace of a rival on a steep climb--crack. And now the world has been reduced to a contest between Ben Bernanke's Printing Press and Chinese Factories. Bernanke makes dollars. Lots of them. And with them, American's march off to the front at Wal-Mart and buy up Chinese goods. Can we buy them faster than the Chinese make them? We'll see. But the printing press is a weapon of mass destruction par excellence. It destroys the purchasing power of a currency. But as long as the Chinese keep lowering prices, even inflated dollars will get you a cheap pair of shoes. The game is afoot... A more serious question is whether the Chinese are deliberately putting the pedal to the metal in order to bankrupt American and foreign manufacturers. Out produce everyone, drive prices so low that only are left selling at above production cost (since your costs are so low.) Crack your rivals. 21st Century Economic Warfare VS. And today, we have this from Reuters: "Chinese factories powered ahead in August, churning out more cars, mobile phones and electronics to feed an insatiable export engine amid growing fears of an overheating economy. "Industrial output grew 17.1% percent from the previous August. " Song Guoqing the chief economist at China Stock Exchange Executive Council, said Chinese GDP would grown between 8% and the THIRD QUARTER. "A large proportion of such industrial goods are to be sold in the U.S. and European markets," he also said. You don't say? August's year-over-year rise was even better than the 16.5% rise in July and the 16.9% rise in June. Don't look now...but that looks like a sustained and perhaps, intentional rise, in production. It's possible this is post-SARS back-log kicking in. But it's also possible that a rising Eastern power realizes it can't compete militarily with a U.S. hyper power at its zenith. Yet the Chinese covet Middle Eastern oil. And they know that in the long run, there is probably more consumption growth to be had in the younger economies of Asia than in the American market. If you assumed that at some point in the next 50 years you and the Americans were going to be in a contest for scarce natural resources, and that as long as the Americans had the guns and navies and planes, you couldn't compete with them in conventional military ways, what would you do? What kind of unconventional war would you fight? Economic? Would you systematically over produce manufactured goods to gut your chief rival's industrial base? Would you use the dollars you got back from your huge export surplus to buy his bonds and literally indebt him to you? Or would you use those dollars to buy his factories and companies from him? And after doing this for 10 years or so, how much of his financial strength would you have eroded, or transferred to yourself? Would he have the resources to finance his military adventures anymore? And by owning his factories and a good chunk of his bonds, would you exercise a leverage over his foreign policy decisions that gave you everything you could gain from a military victory, without ever firing a single shot?

Et Voila

Bring on the trade wars. A wire story reports that,"A group of US senators called for an across-the-board tariff increase of 27.5 percent on Chinese imports in a proposal aimed at prodding Beijing to drop its currency peg to the US dollar. " Chuck Schumer from New York says that "Chinese actions endanger American and world commitment to free trade and weaken the support in Congress for free trade. This legislation is a tough-love effort to get the Chinese to stop playing games with their currency in order to level the playing field for American companies trying to compete with goods and service coming from China." So many twisted half-truths. Where to begin? American commitment to free trade? See also, steel tariffs, farm subsidies. Tough-love? Okay, that might be right. Schumer is just the type to love the Chinese communists (if they'd just play fair.) Playing games with their currency? Hmm. Sounds familiar... Where is the shame America? Where is the outrage? When will the Chinese start selling (or stop buying) U.S. bonds and kick back?

September 09, 2003

The New Fund Industry: Exchange Traded, Not Mutual

Headed over to London on Thursday to meet with some brokers at Man Financial about buying London’s gold ETF for U.S. investors. A bullion backed, London-listed ETF looks like it will arrive on the scene in England before it hits the States. You can already buy Australia’s gold backed bullion fund. Gold Bullion Limited has sold almost 130,000 ounces or about 4 tonnes of gold since listing the ETF on the Australian Stock Exchange at the end of March. It trades on the ASX under the symbol GOLD. You can see by the chart below that a basket of unhedged gold stocks in the U.S., as measured by the HUI, has roundly clubbed the new bullion-based ETF. True. But this is more a question of liquidity, which should not be a problem for a U.S. listing. What’s more, the ETFs will be backed by real gold, rather than the stocks of gold companies. Demand for Gold Liquidity a Good Omen Later this week I’m going to show you an easy way to own physical gold. But for most investors, the easiest way to own gold will be through an exchange traded fund backed by bullion. ETFs, ishares, and HOLDERS, all of which I call precision guided investments, are simple ways to own a liquidly traded basket of stocks in a specific sector, country, or asset class. Index funds, which are not actively managed, have much lower expense ratios than mutual funds. And you can trade them during the day. Imagine that…not only do you not have to pay some hot shot’s big salary…you don’t have to risk him letting his banker buddies trade your mutual fund after the close at prices you don’t get. It’s a much better deal for the average investor. And it’s one reason I think this IS the new investment strategy for a high-risk, low-return market. You lower your costs, take more intelligent risks, and if you wish, leverage it with options. Wall Street knows the public never tires of new investment products, especially ones that actually make investors money. That’s why I wasn’t too surprised to see an article in today’s Wall Street Journal over a brewing debate between the exchanges about how to list index options. A few exchanges want options listed on multiple paces. Others want to maintain the status quo. Right now, each individual exchange bids for the right list options on a particular index. For example, the Philadelphia Stock Exchange recently beat out the Pacific Exchange over the right to trade options on the Nasdaq Composite. When you consider that the Qs, the tracking stock for the Nasdaq 100, did over 69 million shares in volume yesterday and had the third highest trading volume of all U.S. listed securities…you can see why getting the rights to trade options on a popular index makes a difference to even a large exchange. Heavy trading volume generates huge revenues for an exchange. If index options get listed on multiple exchanges, you’ll see more volume, more liquidity, and probably tighter spreads. This is all good news. The Philly stock exchange says it’s less likely to list index options if they’re listed in multiple places. And of course it would say that. After all, less profit if you have to share trading and spreads get tighter. The mutual fund industry is already in trouble with its high management fees and poor performance. And with this new scandal coming out about illegal trading--it could deal a deathblow to investor confidence in the fund industry. In fact, look at the chart below courtesy of the top-shelf guys at Bianco. It shows you just what can happen when the retail investors loses confidence in an idea. His cash does the talking. (also note the disturbing recent spike of cash back into growth and capital appreciation equity funds...a sure sign that the hyper-bull mentality is back, at least for a few months) When Panic Attacks: Cash Can Leave Funds as Quickly as it Flows to Them What better product to fill the void than index ETFs? If the ETF can start getting more assets under management, it could replace the mutual fund industry entirely. There will be issues to be worked out, like making it possible for 401(k) investors to get in and out of ETFs and trade options. But the investment demand is already there. It’s a matter of when, not if.

Ooooh, Pretty New Money

I've got it, let's make the currency more colorful. Who wouldn't want to own something so sharp-looking? No need to place an advance order. Supplies are sure to last. NEW ANDREW JACKSONS TO DEBUT IN MAY, 2004

Defitics Turning U.S. Into Russia, Bond Market Calls

The world has fallen into fiscal and monetary madness. Normally, increasing the supply of something causes its price to fall. Not so with U.S. bonds lately. President Bush is asking for $87 billion to nation build in Iraq and Afghanistan. The Federal deficit could top half a trillion dollars this year. Yet T-Bond futures are rising. How to explain this? Ten Year Note Futures on the Rise Only two ways, really, and the first is so unlikely as to barely deserve mentioning. But it could explain things. It COULD be that the bond market sees inflation ahead later this year. In this scenario, we find the bond market and the Fed in a heated disagreement. The Fed plans to keep in short-term rates low for as long as it takes to “get America moving.” The bond market, judging by the action in the futures market, thinks the Fed is wrong and that the economy is already moving. I find this explanation…way too simple and completely at odds with the economic evidence. There’s no telling what the bond market is “thinking.” You can only see what it’s doing. And the latest commitment of traders report shows that for the reporting period ending September 2, Commercial traders are net long 53,097 contracts in T-bond futures. That’s a 15% increase from the previous week, says John Kosar at Bianco Research. The “smart money” is still betting on a bond market rally. But a bet on a bond market rally is not the same thing as a bet on inflation. In fact, it could be the opposite…a bet on Deflation. This is the second explanation for rising bond prices and one that makes more sense to me. It means the current global financial regime of U.S.-led consumption and Asian over-production may have a yet another round in it. No regime change yet. Ultimately, this is only compounding the disaster for the world’s financial system. It encourages more U.S. debt, more global over production, and the bastard offspring of the both phenomena, debt deflation. And it’s putting the U.S. in a foreign policy in the hands of foreign bond holders. More on that in a moment. For now, it looks like the Japanese and Chinese are content to keep their currencies low (and their exports competitive) by buying bonds with all those U.S. dollars they get from free-spending American debtors. The Bush people must be of two minds about this. One, they know that cheap imports from Japan and China keep American consumers borrowing and spending. Good for GDP. Good for CNBC. Two, they know that cheap imports from China and Japan are profit killers for American manufacturers--and THAT is a political issue the Democrats are already running with. What to do? Bush and Snow will make noise about Chinese revaluation. But it’s really up to the Chinese, not George Bush. Asia accounts for 39% of all U.S. bond purchases. Japan and China alone own a combined $565 billion in U.S. bonds. This is the deflationary dynamic that’s bond supportive. Asia overproduces and takes global profit margins down to razor thin margins, driving out all the competition and dumping the dollar proceeds into bonds yielding 4%…or 3%….or 2%…or less. A geopolitical eco/conspiracy question for you: Could it be a calculated Chinese strategy to wreck the world’s economic and military hegemon (the U.S.) by deliberately producing below the cost of production…making more goods in China than can possibly be sold in the world in order to pummel American industry into oblivion? It COULD be. But even if it’s not deliberate, it partly explains the persistent foreign buying of bonds despite the growing U.S. supply. Time to own bond calls again. TEN YEAR NOTES LOOKING BULLISH Meet the New Russia: America 2004 You may be one of those investors who find it inconceivable that the United States is a bad credit risk. And when bond prices rise even as the U.S. twin deficits (federal and current account) get larger, it’s hard to argue that foreign buyers are getting nervous about the size of the debt. And the conventional thinking is that foreign bondholders are in some way beholden to the dollar the more they buy U.S. bonds. After all, unless they support the dollar by buying U.S. assets, the dollar falls, and the value of their dollar-denominated assets falls with it. But it IS possible that in the near future, U.S. debt levels will be so high that it forces a huge revaluation of the dollar, whether anyone likes it or not. Who knows exactly what precipitates the reaction an investor has that a given piece of paper is not worth nearly what was paid for it? A housing recession. A unemployment rate of 10%? Regardless of what will cause the dollar crash, foreign bondholders will suddenly find they have a tremendous amount of geo political leverage. U.S. debt will have to be paid, either in an inflated currency, or another, less conventional way, with a different kind of currency that you might call….policy complicity. We may soon see the day when foreign bondholders call the shots on U.S foreign policy. In exchange for U.S. flexibility on say, the Palestinian question…or North Korea…or India…foreign bond holders either forgive a portion of the U.S. debt or renegotiate it on favorable terms. Sounds crazy? Maybe. Think of how the Russians have turned their outstanding debts (and nuclear arsenal) into political leverage. No one can afford to let Russia fall apart. Russia, under Putin, has been able to use its delicate debtor status to renegotiate favorable terms on debt (rather than defaulting again), attract capital (to prevent catastrophe, of course), and exert a disproportionate influence on regional and global events. It’s not exactly a position of strength. Yet it turns a primary weakness to its best use. It’s something U.S. politicians may need to learn quickly. Or course, they’ll probably keep right on spending until they’re forced to quit. And it’s clear that as long as U.S. politicians decide to pursue the War on Terror, the government is going to run larger and larger deficits. There will be no spending cuts in an election year. And it’s hard to imagine either Bush or a Democratic candidate taking office on a program of sweeping defense and domestic cuts. There may be a Democrat who will campaign to eliminate the Bush tax cuts. But not a one of them will touch spending. And so higher the twin deficits go…at what price, we don’t yet know…

Archives Up!!

Quick note...spent the bulk of the day yesterday with tech mavens fixing the archives button. The good can now go back and view previous posts. And the "Home" button should be on each page, so if you want to jump back to the most current post, just click "home." New features will be added soon...but for's back to blogging on the markets. regards, Dan