The great thing about running an online newsletter is that it is not only self-correcting, it is self-enhancing. Whenever I make a mistake or state a factual error, my inbox catches on fire when corrections, additional data, and chastisements. Ditto when I exclude some key points to bolster my own arguments. So I thought I would publish a letter I received from a reader from the subcontinent regarding yesterday’s piece on “India is Catching Up With China”.
I am surprised in your comparison with China because you have missed several important points. India is a democracy. It does not have a Ponzi/mafia political party which focuses on looting the nation. Check out the number of billionaires in the Communist Party of China. Patents are relatively much safer in India. The press is free and vibrant. There is no “mad” overcapacity in anything like empty buildings/cities and the like.
The Indian judiciary is slow and generally very fair. India does not have problems of one child policy. Air pollution in Indian cities is probably lower. Most importantly: the fundamentals of the Indian economy in many ways are better than the Chinese. India does not control its currency artificially. There are fewer Indians trying to run out of India than Chinese trying to run out of China. In fact, most Indians can take foreign currency outside the country up to a limit. Few do it in China.”
Here’s the Better Bet
“The number one performing stock market of the past ten years in nominal terms has been Zimbabwe. But if you bought equities there you lost all your money because the ZWD$3 trillion you made now buys you three eggs,” said Kyle Bass of hedge fund, Hyman Capital.
“The number one performing stock market of the past ten years in nominal terms has been Zimbabwe. But if you bought equities there you lost all your money because the ZWD$3 trillion you made now buys you three eggs,” said Kyle Bass of hedge fund, Hyman Capital.
First there was your grade point average, then your SAT score, followed by GMAT and LSAT scores, and finally your FICO. Now there is a new metric with which you will be judged, your “Influencer” score.
A new breed of marketing research firms are using data from social media sites, like Facebook, Linkedin, and Twitter, to rank members according to their ability to spur their friends to action. Companies like Klout, Peer Index, and Twitter Grader are using complex algorithms to mine their data and rank members. This is far more than just a simple listing of “friends.”
Scores range from 1-100, with a major league socializer achieving a 40 ranking, and someone like Bono or Martha Steward coming in at a godlike 100. These scores will be made public and could have a major impact on you career prospects, your credit rating, and even your sex life. I can hear this conversation coming already: “Thanks for the invitation to the opera, honey, but I have a better offer from an 80 to go to the Giants game.”
Do you like your new BMW, American Express card, or Rolex watch and are talking about it with your friends? Advertisers are willing to pay big bucks to get to know you. Last year, Virgin America airline offered free tickets to Los Angeles and San Francisco to highly ranked influencers, while Audi made available special discounts for a new car. Las Vegas casinos are giving away weekends with complimentary show tickets and generous room service tabs.
I have to tell you that I am looking forward to the new system. I just passed 1,000 friends on Facebook and have a massive Twitter following. My website gets 30,000 hits a day and is read in 125 countries, so I should score pretty highly. I understand that Maria Shriver has recently become available. Hey, Maria! Want to check out my 90? I’ll even fire my cleaning lady!
Will a 90 Tickle Your Fancy?
“For the president to not focus on the financial industry in the wake of a financial crisis, he would have to be blind,” said former Federal Reserve governor, Paul Volker
It seems that all you hear about these days is deflation. That is certainly what the bond market is telling us, with my screen blaring at me a miserable 1.58% yield for the ten year Treasury bond.
But there is a new definition for this economic malady that applies to we hapless consumers. In the new deflation, the value of our income falls, while the prices of things we need to buy are going through the roof. It is a particularly pernicious form of deflation, as it is burning our candles at both ends at the same time.
Take a look at the chart below, showing the cost of college tuition versus the consumer price index and home prices. This hits home particularly hard, as I have just put three kids through college, and am reduced to riffling through the sofa cushions looking for spare change or washing windshields at street corners on weekends in order to meet the bills. When I graduated from the University of California in the seventies the tuition was $3,000 a year. Today it is $16,000, and climbing at a 20% annual rate.
The saddest part of the story is that rampant wage deflation means that recent graduates have a grim choice between taking a poorly paid job, or no job at all. That leaves them woefully unable to repay the student loans they ran up to obtain their rapidly devaluing diplomas. The $1 trillion in outstanding student loans is begging to become the next subprime crisis.
And if you were planning on becoming a teacher, forget it, unless you want to move to Saudi Arabia, Russia, or South Korea. After watching tens of millions of jobs get shipped to China over the last decade, did you expect anything less? Just add this problem to the ever lengthening list of ways we are getting screwed.
Deflation Can Be a Bitch!
“For the last 20 days, I feel like I have played psychologist more than I have played money manager,” said financial talk show host, Kyle Harrington.
The wild whipsaw movements in the markets on Thursday reminded us once again how dependent they have become on monetary stimulus from central banks. As if we needed reminding. Almost simultaneously, officials from the US, Japan and the UK hinted at a coordinated move at this weekend’s G-20 meeting in Cabo San Lucas, Mexico.
Let’s hope for the sake of global financial stability that no one eats a bad taco down there. And say “Hello” to Miguel for me at the notorious drinking establishment, The Giggling Marlin. Just make sure he doesn’t pick your pocket when he hangs you upside down by your ankles with a block and tackle to give you a tequila shot.
The rumors were enough to cause me to cover my sole remaining short position in the S&P 500 (SPY) and bat out some additional shorts in the Japanese yen, which would go into free fall in such a scenario. If the rumors are true, they will take the (SPX) up to 1,400 and I will make a killing on my hefty long positions in (AAPL), (HPQ), (JPM), (DIS) and shorts in (FXY) and (TLT). If not, then the large cap index will revisit 1,290 one more time and I will be left looking like a dummy while posting an embellished resume on Craig’s List.
To see how closely risk assets are correlated with quantitative easing, take a look at the chart produced below by my friend, Dennis Gartman of The Gartman Letter. It graphically presents the market response to QE1, QE2, and Operation Twist, which are highlighted in green. In fact, quantitative easing has become the on/off switch of the financial markets. Hence, we get “RISK ON”/”RISK OFF” gyrations in spades.
While on the topic of monetary policy, let’s consider the implications of a Romney win in the November presidential election. The former Massachusetts governor and son of a Michigan governor has said that he would fire Federal Reserve Governor, Ben Bernanke, on his first day in office.
Well, he actually can’t do that, although it is great fodder for the faithful on the hustings. What he can do is appoint and anti QE, pro-austerity replacement when Ben’s second four year term is up on January 31, 2014. At the top of the list of replacements are Stanford University’s John Taylor of Taylor Rule fame and sitting non-voting board member, president of the Dallas Fed, and noted hawk, Richard Fisher.
How would the financial markets react? Much of the recent buying of stocks and other risk assets has been on the assumption that the “Bernanke Put” would kick in on any serious selloff. No Bernanke means no Bernanke put. I can already hear portfolio managers thinking “What, you mean there is risk in these things?” and heading for the exits as quickly as possible. The resulting market crash could make 2008-2009 look like a cake walk. Your 401k would rapidly shrink to a 201k, and your IRA would become DOA. So be careful what you wish for.
That is unless you are a reader of this letter and a subscriber to my Trade Alert Service. Such a market meltdown would be one of the great shorting opportunities of the century. But to follow the game you have to have a program.
Time for Another Shot of Monetary easing
“This is not 2008 or 2009. People are getting overblown with this hysteria. We are only 10% off the highs and have only given back gains. It’s like you wife may have been expecting diamond earrings and now she got a blender,” said Alan Knuckman, chief trading advisor at onestopoption.com.
With smoke still rising from the ruins of the recent silver crash, I thought I’d touch base with a wizened and grizzled old veteran who still remembered the last time a bubble popped for the white metal. That would be Mike Robertson, who runs Robertson Wealth Management, one of the largest and most successful registered investment advisors in the country (click here for his site).
Mike is the last surviving silver broker to the Hunt Brothers, who in 1979-80 were major players in the run up in the ‘poor man’s gold’ from $11 to a staggering $50 an ounce in a very short time. At the peak, their aggregate position was thought to exceed 100 million ounces.
Nelson Bunker Hunt and William Herbert Hunt were the sons of the legendary HL Hunt, one of the original East Texas wildcatters, and heirs to one of the largest Texas fortunes of the day. Shortly after president Richard Nixon took the US off the gold standard in 1971, the two brothers became deeply concerned about financial viability of the United States government. To protect their assets they began accumulating silver through coins, bars, the silver refiner, Asarco, and even tea sets, and when it opened, silver contracts on the futures markets.
The brother’s interest in silver was well known for years, and prices gradually rose. But when inflation soared into double digits, a giant spotlight was thrown upon them, and the race was on. Mike was then a junior broker at the Houston office of Bache & Co., in which the Hunts held a minority stake, and handled a large part of their business. The turnover in silver contracts exploded. Mike confessed to waking up some mornings, turning on the radio to hear silver limit up, and then not bothering to go to work because knew there would be no trades.
The price of silver ran up so high that it became a political problem. Several officials at the CFTC were rumored to be getting killed on their silver shorts. Eastman Kodak (EK), whose black and white film made them one of the largest silver consumers in the country, was thought to be borrowing silver from the Treasury to stay in business.
The Carter administration took a dim view of the Hunt Brothers’ activities, especially considering their funding of the ultra-conservative John Birch Society. The Feds viewed it as an attempt to undermine the US government. The proverbial sushi hit the fan.
The CFTC raised margin rates to 100%. The Hunts were accused of market manipulation and ordered to unwind their position. They were subpoenaed by Congress to testify about their motives. After a decade of litigation, Bunker received a lifetime ban from the commodities markets, a $10 million fine, and was forced into a Chapter 11 bankruptcy.
Mike saw commissions worth $14 million in today’s money go unpaid. In the end he was only left with a Rolex watch, his broker’s license, and a silver Mercedes. He still ardently believes today that the Hunts got a raw deal, and that their only crime was to be right about the long term attractiveness of silver as an inflation hedge.
Nelson made one of the great asset allocation calls of all time and was punished severely for it. There never was any intention to manipulate markets. As far as he knew, the Hunts never paid more than the $20 handle for silver, and that all of the buying that took it up to $50 was nothing more than retail froth.
Through the lens of 20/20 hindsight, Mike views the entire experience as a morality tale, a warning of what happens when you step on the toes of the wrong people.
Silver is Still a Great Inflation Hedge
“For Europe to be competitive, to reflect the seizing up of the economy, you need a Euro that is at par or lower,” said John Brynjolfson, managing director of hedge fund Armored Wolf.
The call was scratchy and barely audible. I was instructed to not mention any names. I should only use the prearranged code words when talking about political parties. You never know when the phones in China are tapped. I was just about to get a heads up that the People’s Bank of China was going to lower interest rates for the first time in four years.
Of course, we knew this was coming. Three relaxations of bank reserve requirements over the past six months telegraphed that the Middle Kingdom’s economy was slowing and that some serious monetary easing was on the way. But it appears that the things were now starting to get out of hand, possibly taking the GDP growth rate below the government’s 7% target.
Chinese companies were canceling contracts to buy imported commodities left and right, including for corn, sugar, copper, and iron ore, causing much distress among foreign counterparties. Now we learn that there are two dozen ships sitting off the Chinese coast fully loaded with coal, with no takers. The Chinese are walking away from contracted deliveries and refusing to pay, much as they did at the height of the 2008 financial crisis.
The really fascinating point that my friends in Beijing were trying to hammer home is that the current round of weakness is setting up the buying opportunity of the century. China is in the midst of changing government for the first time in a decade. The new president, Xi Jinping, is expected to take power in March, 2013, and will owe a broad range of constituents favors for his successful ascent. To solidify his position he will engineer a broad rise in the country’s standard of living that will benefit everyone in the country.
The first order of business will be to clean house and install loyal cadres across the upper tiers of the bureaucracy. Then he will launch a massive stimulus package designed to accelerate the growth of the domestic economy and wean the country off of its dependence on low waged export industries. The goal will be to move the Middle Kingdom’s economy inland, away from the coast where it is now concentrated.
That will enfranchise more of the 400 million of the rural population who have yet to participate in the modern economy and enjoy its benefits. The ultimate coal will be to raise Chinese per capita incomes from the current $3,000 to the $10,000-$20,000 range. A spin off advantage of this policy will be that it improves relations with the US, which until now has been drowning in Chinese exports in many politically sensitive industries. The economy will boom.
To finance this effort, the government will embark on a large scale privatization of state owned assets. Targeted is the government’s ownership of wide swaths of the banking, insurance, railroad, telecommunication, and energy industries. The effort will mirror the privatization policy that Margaret Thatcher imposed on the United Kingdom from the early 1980’s and the one the Japanese initiated a few years later. I participated in both, and the trading profits I took in were more than generous.
The funds that the Mandarins in Beijing will raise from this campaign will be used to pay off its enormous domestic debts. It will also be spent on repairing China’s badly tattered social safety net, with huge expenditures earmarked for health care and social security.
Stock markets will enjoy a major bull market for a decade, both in China (FXI), surrounding Asian emerging nations, like South Korea (EWY), Taiwan (EWT), Thailand (TF), Indonesia (IDX) and in Australia (EWA). Their currencies will rocket too, including The Australia (FXA), Singapore, Hong Kong, and Taiwanese dollars, as well as the Korean won.
The industry plays here won’t be the big infrastructure ones that worked so well in the last bull market, but instead will be focused on the country’s nascent consumer sector. I obviously need to do more work in this area, and when I get specific names, I will let you know.
Investments made near the current lows should see tenfold to twentyfold returns in coming years. This will also pave the way for full convertibility of the renminbi which could lead to the same sort of 300%-400% appreciation that we saw with the Japanese yen from the 1970’s to the 1990’s. That will create a double leveraged, hockey stick effect on the profits on Chinese investments.
What all of this does is to keep the Chinese economy growing at a 6%-8% rate for the indefinite future. While this is a slower rate than seen in years past, it will be off a much larger base, so the impact on the global economy will be substantial. China now boasts the world’s second largest economy, with GDP at $5.5 trillion, still well behind the US at $14.5 trillion.
Needless to say, basic commodities, like copper (CU), coal (KOL), iron ore (BHP), (RIO), all the food plays (CORN), (WEAT), (SOYB), (POT), (MOS), soar in this scenario. Gold (GLD), silver (SLV), platinum (PPLT), and palladium (PALL) also do extremely well. This could be the base case for taking the yellow metal up to my long term target of $2,300 an ounce, or even to the gold bug levels of $5,000 to $10,000.
So when does my friend expect the greatest bull market of all time to begin? After the new government comes in next March you should allow six months for it to get settled and get its ducks lined up. That takes us out to October, 2013. Until then the stock market will continue to bump along the bottom, as we have seen for the past year. Of course, if the markets get a whiff of what’s coming, they could react much sooner. You can take the China crash scenario and throw it in the trash.
I asked my contact if the demographic wall that I expect China to hit in five years will cool his expectations. This will happen with the population pyramid inverts as a result of its 32 year old one-child policy, and a large aging population supported by a smaller generation of young workers creates a large economic drag. He said that demographic effects won’t really impact the financial market for ten years, and could well be what brings the next bull market to an end.
Buy the Next Low
“Public sentiment is everything,” said Abraham Lincoln.
Say goodbye to 2012. That was the harsh conclusion of the marketplace after the release of the devastating May nonfarm report that forced the Dow to give up its entire year to date performance.
The cat was really set among the pigeons this morning when the Department of Labor informed us that only 69,000 jobs were gained in the previous month. The unemployment rate ratcheted up to 8.2%. “RISK OFF” returned with a vengeance, sending stocks, commodities and oil into a tailspin. Bonds roared, the ten year Treasury reaching the unimaginably low yield of 1.42%. Japanese style bond yields here we come.
The truly horrific numbers were the revisions, which saw the jobs figure for March cut by -11,000 and April by -38,000. The biggest gainers were in health care (+33,000), transportation and warehousing (+33,000), and manufacturing (+12,000). The losers were in construction (-28,000), government (-13,000), and leisure and hospitality (-9,000). The long term unemployment rate jumped from 5.1 million to 5.4 million. The inexorable trend of a shrinking government and a growing private sector continued.
Administration officials made every effort to put lipstick on this pig, and were at pains to point out that this was a seasonal slowdown that occurs every year. The operative word here is that jobs were “added”. They argued that the real focus should be on the 4.3 million private sector jobs created in the last last 27 months. The markets didn’t buy this glass half full interpretation for a nanosecond.
Of course, further talk of quantitative easing came to the fore once again, preventing an even bloodier sell off, forcing traders to keep a hair trigger on their shorts. From here on, the government is going to attempt to make life as uncomfortable as possible for short sellers who are seen to be restraining the grand design. As I always tell traders in these conditions, make the volatility work for you and run towards it, not against it.
Don’t expect the Federal Reserve to rise to the rescue of risk assets anytime soon. It has so little dry powder left that it is unlikely to move until market conditions dramatically worsen. My bet is that the Fed won’t take action until the S&P 500 hits 1,100. The problem is that we may get our wish.
Looking at the charts below, you can only conclude that there is more pain to come. Commodities, the first asset class to enter this selloff, look like they will be the first to hit bottom. Oil (USO) is at my downside target of $85, copper (CU) is rapidly approaching my $3.00/pound goal, and gold (GLD) keeps bouncing off of my $1,500 floor.
Since equities were the last to top, they may become the last to bottom. Therefore, I think we may be two thirds of the way through this downturn on a price basis, but only half way on a time basis. That analysis sees a new major rally postponed until August at the earliest. It also made 1,250 the next stop on the downside and 1,250 an obvious medium term target.
For those who took my advice to sell in May and go away, good for you. Go blow your profits on a vacation in the Hamptons this summer. And have a mojito for me.
“I will believe that corporations are people only when the states of Texas and Alabama start executing them,” said former Secretary of Labor, Robert Reich.
“A lot of new economics involves the reading of a lot of old books,” said Nobel Prize winning economist Paul Krugman.
For those who wisely ignored my advice to sell the SPDR Gold Trust Shares ETF (GLD) June $160 Puts on May 3, good for you. The options are now trading at $10.50 and you have a profit of 147%, adding 14.7% to your annual return. This will no doubt be your home run trade of the year.
If you still have these, it is time to give thanks for your good fortune and head for the sidelines. You don’t get to do trades like this very often. Selling out here allows you to avoid the time decay hit as we run into expiration on June 15.
Gold has now fallen $100 since my last ill-timed sell recommendation. Tough luck if the rumor that the International Monetary Fund was going to sell its gold reserves to bail out Europe hit the wires two days later. I had heard about this from my European central banker friends a month earlier, which is why I put on such a big short position in the first place. Alas, timing is everything in this business.
The yellow metal is now approaching both a severely oversold condition and major support at $1,510, and it would be unwise to continue to run the position. The same is true for every other risk asset in the universe, including the S&P 500 (SPX), the Russell 2000 (IWM), the NASADQ (QQQQ), oil (USO), silver (SLV), copper (CU), the Euro (FXE), and the Australian dollar (FXA).
Use whatever metaphor you want; the rubber band has been stretched to the breaking point, the paddlers have all bunched up at one end of the canoe. The dollar index is up 13 consecutive days, and the Dow is down 9 out of 10. How long do you want to keep flipping a coin and relying on heads coming up every time?
In the meantime, the big “RISK OFF” assets of Treasury bonds (TLT) and the Japanese yen (FXY) are starting to make rather shrill topping noises, giving additional signals that it is time to shrink your book.
Finally, I have my own performance to look at, with May thankfully the most profitable in the 18 month life of my Trade Alert Service. As of this morning’s marks, I am up an eye popping 22% so far this month. If the past is any guide, big numbers like these are a great “sell” indicator. Mean reversion can be a cruel and unfeeling bitch, worse than an Internet date, so watch out.
Take profits here and you will have plenty of dry powder to resell the barbarous relic and other risk assets in any dead cat, short covering rally that may unfold into the May month end book closing and into June. Then we can position for the final low in the summer, which should be downright scary.
Sell these ETF Alternatives:
Time to Pare Back Some Risk
When I heard that the managers of exchange traded funds were raking in huge fees from lending out shares in their index portfolios I thought “That’s great, the managers are really working hard to maximize returns for their shareholders.” These shares are borrowed by hedge funds which then then sell short. Then I found out the ugly truth.
I was horrified to learn recently that the fund operators are keeping a substantial portion of the fees to be paid out in profits and bonuses for themselves. According to an investigation by the Financial Times, the largest ETF operator, Blackrock, kept, $57 million of $164 million in lending fees earned, while State Street kept 15% of the total. Others are thought to keep as much as 50%.
The problem is that the investors take all the risk in this securities lending, but reap only a portion of the benefit. Sure, the lending is fully collateralized and marked to market on a daily basis. But has anyone figured out what happens if your borrower goes bust, as hedge funds are frequently prone to do? Involvement in litigation can cost millions, and I’m pretty sure that the managers aren’t assuming their share of that liability.
By engaging in this activity, fund managers are making it easy for speculators to drive down the value of the lending fund, wiping out shareholder equity. Am I the only one who sees a conflict of interest here? It is the classic sort of “Heads, I win, tails, you lose” type of management philosophy which has sickened me over the years and seems to be getting worse, but which has become institutionalized.
ETF operators insist that this activity is disclosed in the prospectus. But the exact share of the profit split they keep isn’t. You can always vote with your feet, and flee the funds that are withholding the most in fees. Good luck figuring out who they are. This is the kind of regulation that the industry is spending hundreds of millions of dollars in Washington to defeat. And you wonder why people are so pissed off at Wall Street.
I’ll Keep the Change
I follow a broad range of unconventional, but highly useful leading economic indicators that gives me a decisive edge when predicting the future direction of global financial markets. One of them has started flashing a warning sign.
I fund an orphanage in remote Zhanjiang, in China’s southern Guangdong province near Hainan Island called The Zhanjiang Kids Organization that catches the kids who missed out on China’s economic miracle. Lacking America’s social safety net, child abandonment in the Middle Kingdom usually leads to a cruel death through malnutrition or disease at the few primitive public institutions that exist. With China’s one child policy now 30 years old, most families prefer their sole heir to be a boy, which means that girls account for the vast majority of orphan children.
Recently, there has been an upsurge of children dropped off at the orphanage and a sudden increase in the age of the kids. Twelve year old boys are being dumped because they cannot be fed. For a Chinese family to give up a boy this close to working age is truly an act of desperation. As a trader, this is all proof to me that the Chinese economy is slowing faster than people realize and that the global economy will take a deeper dip this summer. Indeed, the People’s Bank of China affirmed as much by once again easing bank reserve requirements again last night.
I usually avoid organized charities like the plague. The great majority are scams where 95% of the funds raised go to “administrative costs” that usually end up in someone’s bank account. As we all know, the corruption in China is rampant.
The Zhanjiang Kids Organization is a rare exception. I know the organizers personally, who originally got involved by adopting a couple of girls there, and they are saints. They carefully oversee the spending of every single dollar, assuring that it gets spent for its intended purposes. Instead of doling out cash to local organizations which often gets lost, as other organizations do, they undertake physical delivery of desperately needed food, books, and medical supplies. They also organize trips for volunteer pediatricians, educators, and administrators from the US.
To learn more about The Zhanjiang Kids Organization, please visit their website by clicking here at http://www.zhanjiangkids.org/ . There, you can contribute directly through your PayPal account or credit card. If you have any further questions about this fine organization, please contact Susan Doshier directly at email@example.com .
Checks should be made out to the “Zhanjiang Kids Organization” and sent to Zhanjiang Kids Organization, c/o Susan Doshier, 2 Abbey Woods Lane, Dallas TX 75248, USA. Print out a hard copy of your receipt. This organization is set up as a US 501 (3) (c), so all contributions are fully deductible on the 2012 Form 1040, schedule “A”. There is no reason why Uncle Sam shouldn’t pick up one third of the tab.
Those who made a 40.16% return on their investment following my timely advice last year should consider chipping in a few bucks. Newer subscribers who haven’t made money yet can wait. When the big numbers arrive in coming months, you can contemplate a donation then. Do the asymmetric trade here. A $100 gift creates $10,000 worth of benefit. Act in your own self-interest. You may be working for one of these orphans someday. If you don’t, your kids will.
“I view Euro as a doomsday machine,” said a European economics professor.