thoughs and updates....

The second quarter GDP revision was released earlier this week. It was revised upward from 2.5% to 2.9%. Core inflation was at 2.8%. This confirms my suspicions that inflation is now higher than GDP growth.

Practice account update: Shorted Goldman Sachs (GS) (12% off yearly highs) on the rational that the tightening of easy credit that simultaneously provided business and margins is over. Also bought Wellstone (WFLT.OB) again at $0.90. They seem to be expanding their sales base with many more locations selling the brand.

I've been unhappy with my decisions and performance the past two months. I made a big mistake shorting Dow futures. I missed buying Frontline (FRO) at $29.50 and selling at $44.00. Two of my shorts, Escala (ESCL) and Vonage (VG) started out well, but then turned against me recently.

data from the last real estate bear market

I highlighted my favorite part of the article below:

the average house price in L.A. dropped from $222,200 in 1990 to $176,300 in 1996, a loss of 20.7 percent. . . . Furthermore, those are nominal prices, not real values. To calculate the loss more realistically you would have to figure in the cost of inflation: $222,200 in 1990 would have been worth $266,700 in 1996 dollars, which means the actual loss for homeowners buying in 1990 and selling in 1996 was closer to 34 percent. (link)

Wow! That's not a good sign. Now look at this chart below. I see a bubble that's 2-3 times as big as the 1990 bubble.

By the end of this year, I expect to hear a giant wooshing sound as the air comes out of the bubble. Don't forget reflexivity. When the housing bust causes a recession, that will lower incomes, so the base of the graph will sink as well.

Invest in commodities.

Housing Sales

The past two days showed a marked acceleration in the decline in home sales. Since a year ago, existing home sales are down 12.6% and new home sales are down 21.6%. On top of this, inventory has increased from a 5 month supply earlier this year to a 7.3 month supply (existing homes). The housing market numbers are now in a reflexive downward cycle. For example, if housing sales drop another 4.3% next month, the supply will jump by 8.5% (for existing homes). See Commerce Department press release. The collapse is starting to gather steam, and in about 6 months will become an avalanche.

May I remind you that in 1991, sales declines preceeded price declines by 12 months.

Since 2003, median prices have risen by 29%, but inventories are up 70% and sales are about even, according to NAR data. Sales (seasonally adjusted) have dropped eight of ten and four straight months. The supply and sales numbers are diverging, which means that they will get much worse very quickly. It seems to me that none of the analysts out there realize this. Nearly twenty years after George Soros' revealed his ingenius Theory of Reflexivity, the market has still not learned this lesson.

The thing that surprises me is that there's more "word on the street" about a housing crash, than in the normally sensational media. Well, now is the time to position investments for the coming implosion in housing. I see a 20-30% price decline nationwide over the next 2-3 years. It seems to me that the analysts haven't realized that the market peaked at the end of last year. Well, they won't notice the drop until it's halfway down. The question is, how do we use this institutional sentiment to our advantage? In my case, I will patiently wait for a chance to buy a house for a ridiculous bargain.

PDC and Natural Gas

I must admit getting a little worried over PDC lately. What will happen to the stock if we have a mild winter combined with our current record natural gas reserves in storage?

While natural gas prices have climbed from $5.15 to almost $7, the stock has fallen from $15 to under $13, and is now around $13.50. The first chart in this article gives me renewed confidence that my pick, while scary, should be exciting as well. Adam Hamilton says that while natural gas is in a secular bull market, "the fear permeating gas today is overpowering and universal."

Time to buy.

Commodities

Here's some fabulous research from a site I just discovered, Zeal LLC. I found them looking for gold date from 3-5 years ago. When gold was a $270, they were telling people to buy gold because real interest rates were negative. (The fed funds rate was lower than inflation.) According to shadowstats, the real inflation rate is 7.7%. Here's the chart:

I've been doing some thinking and I've come to the conclusion that there's an apparent contradiction in my thinking. I need to make sure that all my ideas point in the same direction so I don't make any self-defeating investment moves. The contradiction involves my belief in the truth of the above chart, while I've made a bet with Al that rates will be below 5% next August. This may be true, but the Fed is between a rock and a hard place, and I made my bet based on my understanding of the Fed's current position. The Fed took great pains to reassure the housing and stock markets that there was nothing to worry about. This was the exact opposite of earlier this year, when Bernanke gleefully terrorized the markets. Right now, the Fed seems committed to a policy of market conciliation. Also, being married to false inflation numbers, and crowing about "core" CPI they will look foolish if they change their tune on it. When the housing bubble pops and the economy falls apart, the Fed will have to lower rates, or at least leave them the same. This means we will have continued high inflation, commodity prices, and a very weak dollar. After they try lowering rates for a while, they may realize that the inflation situation is unacceptable and start raising rates again, but hopefully for my bet, that will be after next August.

More on PDC...

PDC does have it's downside, admittedly. Natural gas inventories cannot keep growing forever. Right now, we are in a vicious cycle where spot prices are kept high by future prices. As long as future prices hold up, spot prices will continue to rise. For the next six months or so, I think PDC will make a killing. It remains to be seen what they do with their money. So far, they are putting it toward capital expenditures. Right now, any downside is limited by their price ($6.65 end of March 2004). Now PDC is at less than double the price ($13.00) but gross profit is up 685%. They have no debt. EBITDA is up 523% over last year. Adjusting share price for cash, they trade at 4.7 times cash flow. These stats are my downside protection.

What would happen if they decided to buy back shares or issue a dividend?

A Bet On Interest Rates

Yesterday, Al and I made a bet on inflation rates. The bet ends August, 2007 and is for dinner at Ruth's Chris Steak House. I bet that the fed funds rate will be below 5%, while Al bet that it would be over 7%.

Inflation.....

Here is a fascinating article showing how China's entry into the gold market has contributed to the metal's rise, and how it might affect it in the future.

According to Inflationdata's forecasts, inflation should dip in September over a year ago because of the inflation caused by hurricane Katrina. It should then jump right back up in October. Based on the accuracy of their past predictions, I think I'll look to buy gold from now until the October inflation numbers come out in November at a six month low (below $550/oz.).

Natural Gas...

Natural Gas futures are above $7.00 through March 2010. The price for future delivery in Janruary 2007 is over $11.00. It's no surprise to me that supplies of natural gas are 14.2% higher than the five year average. Anyone with a storage facility can buy natural gas today for $7 and sell a contract for delivery in Janruary for $11. The EIA keeps track of enery inventories, including natural gas. Another thing I looked at was the amount of storage capacity. It's only at 34%, so it's not even close to being a factor. Although prices are 30% higher than they were three years ago, many people are still betting that prices will fall. I see a lot of upside and a small downside. Inflation is still pushing prices higher, and I think natural gas is even harder to conserve than gasoline. At some point, stockpiles will force down prices, but I think they will stay high unless we have a very mild winter. Natural gas production is 14% higher, but all that excess production is being put into storage.

OUCH!!!!!

Well, that backfired. The bet against the DOW, I mean. That just cost me an 8% loss in two days (on my entire practice portfolio.) Mini DOW contracts were up 155 points today. I still think the bet is correct, but premature. I can't afford another loss like this one, so I'll have to wait for a little more bad news about inflation or the economy, because the market completely ignored the latest housing news. (Sales down 25% in 28 states.) In the meantime, I think I'll move into gold.

On the plus size, my currency investments are doing much better. My slight losses in The Euro and the Swiss Franc are just about gone, and I think that the dollar will continue to drop.

from Barron's Market Watch

Barron's Market Watch is "a sampling of advisory opinion." Here's my favorite from this week. Dr. Ed's morning briefing states that "Global Competition and solid productivity growth should keep inflation in check."

I strongly disagree. First, import prices are up 7% over the last twelve month. Competition is not lowering prices any more. (This is also an indication of what an honest inflation number would be close to.) Second, record productivity levels haven't kept inflation from accelerating in the past two quarters. With productivity at record levels, I see a much steeper downside than upside.

I like AAB.WS. It's a warrant on a basket of Asian currencies that matures in 18 months. It's really an option product. It trades like a stock, but with 6.5 times leverage. I put some in the practice account and am considering it for real. I think it's a good play when the dollar tanks. But maybe gold will be better. I'll have to think about it.

PCU looks like a buy

The Motley Fool has suggested that Southern Copper (PCU) is a buy under $90. Any time a company with good earnings potential has a dividend yield higher than its P/E, it's got to be a buy. People are still worried about the future of commodities, but I think the odds are that they will go higher rather than lower. In addition, I think that if they go higher they will go much higher; if they go lower, they will only slow moderately. The NYMEX futures market takes the second view. Copper prices are still over $3.00 in July 2008. Technical analysis is kind of ambiguous.

In my practice account, I think I will cut back or close my short position on IDT (why short IDT when you can short Vonage (VG)? Depending on how tight my margins are, I will look to buy Southern Copper.

Let's get aggressive!

I decided to get very aggressive with my practice account today. Since the Fed decided to abandon the dollar, I think it's a good time to short DOW futures. I took out the biggest leverage I could (1/3 of portfolio leveraged 100X = 30X entire portfolio). Risky? Yes, but I'm very confident. It's paid back 20% just today!

Tanker stocks

Frontline (FRO) is up 14% in the past three days. Most of this is due to the news that the Prudhoe Bay oil field will be shut down, probably until February of next year. The oil will probably have to be replaced from the Middle East, a 70-day journey. On top of this speculation on spot tanker rates, there is the fact that 6.18 million shares of Frontline were short as of July. Now those short sellers are being squeezed out of their positions. Volume was 1.8 million shares Monday, 3 million Tuesday, and 2.2 million halfway through today. That's a total of 7 million. Average daily volume is 700K. Subtracted, that leaves us with 5.3 million. I think that Frontline could easily go a few dollars higher just on short sellers covering their losses.

Economic outlook

At the end of June, I predicted that the stock market would be up in the third quarter, and down in the fourth. The DOW was up 69 points until today. It should be downhill for a while. The Fed halted raising rated, conceding that raising rates would harm the economy even more than our runaway inflation. (Gas is at an all-time high, and everything I see at the supermarket is more expensive than six months ago.) The DOW was down despite the halt in hikes because the market is afraid that we may have both a recession and inflation. (I think we will.)

I was surprised that the dollar was not lower than it was, but I guess that a rate hike wouldn't have supported it much anyway. My bet is on the Swiss Franc and the Euro over the Yen. Here's my reasoning: I think the French and Germans will try to attack the dollar to make themselves feel important and also because they don't like our support for Israel. I think Japan will devalue their currency as ours falls so that they have a better chance to compete with China. The Swiss Franc has two things going for it. The first is that they have an awesome current account balance in their favor over the past year, and they will continue to attract currency speculation. The second is that their legendary neutrality makes them the ideal currency in a wartime situation.

Update on shorting strategy...

The strategy worked well. Overall, profit was 1% of invested money in a week. Baidu (BIDU) dropped over 19%. However, XM Satellite Radio (XMSR) gained 13%. If I had shorted Starbucks (SBUX), I would have come up big time.

Natural gas inventories

Last week, U.S. natural gas inventories were 2.76 trillion cubic feet. That's 22% higher than average for this time of year. Tomorrow, the new inventory numbers will come out. Oppenheimer analyst Fadel Gheit says, "the high level of inventory is all temporary. Once demand starts, it soaks up a lot of volume in a very, very short period of time." That might push PDC much higher as short sellers look to bail out.

the almighty worth less dollar

My currency trading practice account has been a disaster this year. I was down as much as 72%. However, my recent short against the yen has given me hope of a comeback. Today's news was that the dollar fell on the strongest inflation numbers in 11 years, despite the fact that inflation could prompt the Fed to raise rates again. What the market is saying, is that the Fed has already lost the short-term battle with inflation, even if they do raise rates. My account has recovered 10% to -62% since 7/19.

More offshore drilling coming...

This is good news for Seadrill. The senate approved more offshore drilling today. Support was strong as the vote was 71-25.

Here's some interesting info on PDC. First, natural gas is very high despite higher than average stores for this time of year. I see two trains of thought on this. 1. One could think that supplies are fine and prices of natural gas will plunge. 2. One could come to the conclusion that since supplies are fine and prices are still high, any disruption in supply will cause prices to skyrocket.

Another thing: the short ratio on PDC is 6.5%. (For comparison, Vonage is at 4.2%. and that's my number 1 short right now.) I think PDC will be worth $20 next year when their earnings on the winter season come out. If the short sellers get shaken off, PDC could go much higher.