Sunday, May 30, 2010

Zero Rates Until A New Currency?

Is there a way out of this deflationary debt trap? Will we have permanently low short rates? Will we see sub 2% 10 year Treasury rates? Is it possible the US Fed will never again have a tight monetary policy? Will we avoid the necessary recapitalization through austerity and savings and instead see a final collapse where banks are past recapitalization and central banks have to expand their balance sheets, unsanitized, by five or ten fold? Or, will we see an eventual return of massive inflation?

Are we in a secular bear market, cyclical bull market? If so, will we see traditional bear market values on book value and earnings? Should we hold only hard assets - gold, land, diamonds, unlevered equity? Where is China - overheated and overbuilt economically and unsustainable politically? A sharp slowdown ahead - death to copper, oil, Australia and Canada?

Or are we in the early stages of a sustainable recovery...

Tuesday, May 18, 2010

Settling Down?

Is the market going to settle down this week? The ECB has done all it can for the moment, hiding the current state of insolvency for Greece and possibly others under a shroud of short term liquidity solutions. The US economic indicators, especially unemployment, continue to offer hope to the market. Commodities may be in the dog house until China has resolved it's slowdown methods, but the tech reboot and the delveraging plays are looking like the right places to be. The longer term story is still pretty ugly but it's beginning to look like we have some space for a rally. Samsung just announced a massive spending program on chip capacity which should signal good memory prices for the next 18-24 months and a build up in semi cap back log.

Thursday, May 13, 2010


To be long, short or out? Feeling very much like I should be net short or out of the market. The break down last week was a signal: conviction at these prices is limited. We have climbed the The Wall of Worry for the past year, but the structural issues in housing, unemployment and debt have shown little ability to recover. The big bounce in corporate earnings has come through, but it is hard to see how a sustained recovery can happen in an age of OECD budget austerity, wage stagnation and high unemployment. After a statistically massive year long rally, the odds suggest better prices.
China's Dilemma

China's peg with the US is now a problem for them as the Euro sinks. $1.25 is an important support line, as is $1.16. What happens to China's export machine and margin structure as their biggest trading partner's currency loses buying power? Are they are moving towards a trade deficit? What would be the impact on US treasuries and the dollar? Surely China would be less interested in currency appreciation. The China/US relationship looks to be getting more complicated.

Wednesday, May 12, 2010

Has the Final Card Been Played?

Low and behold the UK and the EZ appear to have got the job done. At least there is now some official recognition of the problems the region faces. And much of these risks are now priced into the market. But its just a bridge into the fog - tough to see how the debt bomb can be worked off without a death spiral on one hand or a grinding austere existence on the other. The euro's look to have successfully kicked the debt ball further down the road (death spiral), much like we did last year, and the UK has gone Tory light (grinding austerity).

This week marks the final tool in the ECB tool kit. While they apparently plan to sterilize sovereign debt purchases with the sale of other debt securities so there is no net change in money supply, they may not have that option. I am moving to net short despite this sense, given the massive bounce over the past year, the major headwind of stagnant economies and the volatility inspired lack of conviction the market seems to be feeling in current prices.

In the context of the confidence game of sovereign debt and fiat currencies, the hopeful continuation of the" economic recovery" in the US and UK and the ever required bullishness of equity managers, we always have to a have a buy list. If the market can settle down in the next 2-3 weeks, the next rally will have me looking at the following trades: commodities, chips, and de-leveraging stories. Either way, it is becoming standard practice to have some long dated, way out of the money S&P puts as the Vix drops to the 20's. A little insurance and now you're a hedge fund.

The China all cash real estate bubble looks to continue for a while and while the Chinese stocks may continue to get hit, the commodity stocks could get goosed from here. The industrial cesspool that is the Gulf of Mexico should ensure for the next year or two a dramatically different approach to offshore drilling and that should help the ten year view that seems to be supporting oil prices.

Most chip companies are saying, the March quarter was unreal - lots of inventory restocking for sure, but you have to wonder after a decade of underinvestment in corporate and infrastructure technology, maybe demand will keep pumping and the survivors will see big leverage. IDTI looks to be transitioning to a high margin mixed signal business, DRAMs are going into mobile phoneputers, and ISSI, a $10 low end chip company says they will print 50c this quarter.

Anything in smart phones will work - it is the emerging market computer. I keep hearing positive things on RIMM due to the fact that it is optimized for messaging and that's what is used by the EM customers (accessing the internet is for the elites). Not sure what happens to their US market share. Clearly, Apple's earnings machine is about to hit on all cylinders but it's hard to pay this premium for a hardware company; is their moat that good? And the semi cap names should be able to get some traction if there really is a cycle coming - AMAT reports soon.

The banks will print another good quarter but have two major overhangs: first, if the government keeps investigating the group will have a tough time moving except for the regionals like BBT and KEY, and second, housing is still a problem. Lots of moving parts with housing - end of the government incentives, rates could be bottoming, lots of shadow inventory, and apparently a large group of underwater homeowners ready to throw the towel in. Another dip in housing prices could start the jingle mail game all over for a whole new group of homeowners that today are close to par but down another 10% they may just punt.

With 3.5% 10 year debt, little premium for junk ratings and a rebounding equity market, now is the time to de-leverage/raise capital. I am still holding BSX (red spots) and names like CPN, CHK, and COP seem interesting. Maybe not sexy, but interesting.

Finally, gold looks to making a breakout but I can't say I am convinced it will hold. If it does, that's bad news for most other markets as it suggests no one believes in the bailouts, the fiats are doomed and inflation is coming eventually. Its behavior might be a signal as to whether the market is willing to play into the current bailout, and there might just be another test for gold holders. The rumors are the only reason for the massive move is huge gold buying in Germany - given that nations history I'll believe anything. Either way, you still gotta hold it and keep buying on dips.

Monday, May 10, 2010

Does a 750 Billion Bailout Matter

The Eurozone has finally admitted how big the financial problem is: 750 billion euros. This is a bailout fund, built with the support of the IMF and a commitment from the ECB to move into quantitative easing, buying sovereign euro denominated debt. So, basically, Europe just got bailed out by the IMF. And I thought the IMF was for emerging market countries...

While this historical move should calm markets in the short term, the longer term issue of insolvency has not been resolved. The financing terms that Greece needs to be on the path to solvency, even with draconian austerity, would be something like 3% average interest rates. And that's for years - mabe a decade or more - and assumes Greece will stick to the plan and will be able to start growing again.

Lurking in the background of this obfuscating bailout is the cold hard math: Greece and maybe 2-3 other Eurozone countries probably will need to default and restructure their sovereign loans, thus ending or at least dramatically changing the Euro experiment. The German Chancellor's party has just lost a majority in the most populous German state. So the anchor tenant in the EZ is a bit like Saks in a failing suburban mall: time top pull out.

That process is still ahead of us, but it is hard to tell when the moment will come that the market sees this inevitable day of reconing; 750 billion should tide things over for the next few quarters until the details of austerity and growth reveal the mirage. So this leaves us with the US, the UK and now the EZ pursuing quantitative easing, printing money to buy up sovereign debt. That's why gold is at $1200 and likely on its way higher over the next 2-3 years. The fiat currency system is in a competitive devaluation game that wont likely end well.

If you look at the total sovereign gold ownership, and overlay resource ownership, it may give you an idea of how to reorder the economic world. Lets start with gold reserves: US (8b tons), Germany (3.5b), IMF (3b), Italy (2.5), France (2.5), China (1b), Switzerland (1b), Japan (.7b), Netherlands (.6b), Russia (.6b). Add in Brazil, Canada and Australia for their resources. Not really sure how to order it all, but clearly the UK is nowhere to be found, Japand and Chian are bouyed by their US sovereign holdings, etc, etc. Maybe a worhtless study, but when we start getting concerned about sovereign solvency what else can we look at?

Saturday, May 08, 2010

Greece Does Have Germany, But Does it Matter?

So in the past 18 months we shifted debt in the US from the consumer and banks to the government, and in Europe from the banks to the government. Given the state of the economies, governments decided they needed to push massive fiscal stimulus to rebuild growth. That created even more government debt.

So now we sit with sovereign debt and deficit ratios that are unsustainable without a minimum level of growth and exposed to a potential increase in interest rates. If growth doesn't pick up, government receipts will not service debt.

Likewise, if interest rates pick up and governments have a significant amount of short term debt (like the US), the cost of debt service will go up. In fact these two issues are linked in that if growth does not pick up, investors will demand higher rates - a pro-cyclical event similar to hitting the proverbial wall.

The events of the past couple weeks reflect this situation: Greece has already hit this wall and needs a restructuring (default). The EZ hasn't accepted this reality yet, as they believe the Greek economy can absorb the austerity plan that the government has passed without a revolution or a slow down in growth that would prevent debt service. The ECB can start buying Greek sovereign debt (quantitative easing), but this is their failsafe - they would have no other weapons. It's turning into a showdown.

The sovereign CDS market provides a ready guide for the status of other EZ countries and the list goes as follows (cost of insuring this debt): Greece 700bp, Portugal 340, Ireland 205, Spain 195, Italy 152, Belgium 92, UK 81 and the US for reference is at 97, up 60% from the end of '09 and up 7x in the past year. Clearly the market is worried about the collective governments' ability carry their debt.

Where do we go from here? Without growth, the system will require a great depression like austerity to preserve any belief in fiat currency. At the end of the day, currency is a promissory note and requires faith in the balance sheet of the issuing country. This balance sheet is backed by the economy, not gold. We currently have countries that appear insolvent, much like banks were insolvent a year ago.

The only real choice is for governments to continue to paper over problems, and inflate their way out of this hole. The US (and as a result much of the world) has had aggressively loose monetary policy for a decade now so it not should come as a surprise that gold is over $1200, many commodities are back to pre-crash highs and picassos are going for $150mm.

With the fiscal stimulus still moving forward, consumers have come back to spend. But for how long? Job growth is still too low to make any impact in the coming months and housing prices do not appear to have completely stabilized. If we add in equity market volatility, then surely the consumer will continue to reassess their savings plan. This new austerity behavior will take time to establish a foothold in the minds of the world's great consumers, but it will eventually. There is no choice.

Despite trading this year long rally poorly, the calls on paper have been pretty good. 10,500-11,000 on the Dow is a big resistance level, and I think technical analysis is as good as any other in a market with poor anchorage. I do think the EZ will figure out some solution that will calm the markets, the UK will work out a better than expected coalition plan, and the US economy will continue to recover. But the recovery will face a reduction in fiscal spending and increased taxes that the sovereign debt markets will demand. And this adjustment will come this year. This correction may include the market's recognition of this difficult position.