Ship Finance International

SFL announced their third quarter results. Tanker rates are half what they were last year in the fourth quarter. I believe that the reason for this is that the opening of new pipelines, and an ample supply cushion has shortened crude trade routes and also released tankers used as storage facilities. That's the downside into next year. However, 60% of (adjusted) profits still came from profit sharing. That's a very good sign for long-term profit growth.

Japan...

"Japan is growing again and, for the first time in a dozen years, it's adding more to global growth than it's subtracting" - William Pesek, Bloomberg. Japan's national debt is "170% of GDP", and their credit rating is "lower than Botswana."

I have two comments on this. 1. Japan is finally contributing to global growth because their banks are healthy again. This will fuel liquidity and possibly inflation. 2. China will not make the same mistake Japan made. They will continue to keep their currency lower than the dollar until they get rich enough to reverse the trade deficit.

the French are scared...

The Financial Times had this to report today:
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A French official said Mr Breton had deliberately changed his tone on the euro, from saying it was “fully valued” when it was trading at $1.24-$1.28 against the US dollar, to calling for “collective vigilance” now it was above the $1.30 mark.
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Hmmm.... sounds like the French are pressuring the ECB to stop raising rates. The stage is set for a huge dollar comeback.

the markets get interesting....

Just look at the headlines. Bloomberg proclaims that "Stocks Fall on Dollar Declines" "Thanksgiving Weekend Spending Rises 19%", "Crude Oil Rises Above $60", and my favorite "Homebuilding Shares Rally Amid Housing Slump."

These headlines are rife with contradiction and confusion, and where there's contradiction and confusion, there's opportunity.

The dollar has dropped for five days straight. This drop has wiped out the 22% profit I just took on the Pound last Wednesday. Darn. If only I had waited a week... Well, I think the economy will be much stronger than these declines indicate and I'm sticking with my bets against the Euro and the Yen. Whether or not we will have a recession in 2007 is something that we will only know in 2007. What we can do now is put all these articles on one side or the other.

The 19% spending rise and the rally in homeowners' shares proclaim faith in the economy. However, with the market predicting a rebound in the housing market in six months, I think this foolish optimism is a great shorting opportunity for ITB. (Never mind, it's already down 2%).

The dollar decline and the rise in crude prices are on the side of a slowing U.S. economy. However, crude creates a contradiction if it's placed on either side of the equation. For example, if the economy slides into a recession, there will most certainly not be enough demand to cause a rise in prices. If the economy has a soft landing, then the dollar will strengthen, keeping oil prices somewhat in check. Does it make any sense to predict a renewed takeoff in oil price? I don't think so, at least not for next year.

Having tried to disentangle the arguments, let me hazard a guess at the direction of the economy with a reason why I believe that. I think the economy will not go into recession, and will rebound strongly because of the massive amount of worldwide liquidity we are currently experiencing.

Almost everyone is predicting that the Fed's next move will be to lower rates, except the Fed. Why doesn't anyone believe Bernanke? Having tried and succeeded in being infinitely more clear about his intentions than Greenspan, Big Ben's reward is to be ignored by Wall Street and second-guessed by everyone who thinks they know more. Well, I think Big Ben's cautionary statements about inflation are worth paying strict attention to. I believe that Big Ben's a man of his word.

In conclusion, the credit cycle is the biggest, widest picture we need to look at. This is what's driving global liquidity. When does the credit cycle contract? When the most diversified credit becomes shaky and topples. These things are caused credit swap derivatives, and they are responsible for encouraging investment banks to continue a global lending spree of trillions of dollars.

comment on the "Bagel Index"

Jim Jubak has some very good ideas. However, this time I disagree with him. He sees a 5.4% increase in inflation in his "bagel index" and concludes that stagflation is coming next year. He says that it comes from "the price of wheat", and his baker confirms this. Here's what I see. Yes, the price of wheat is high, and going to go higher. Farmers will plant a record corn crop next year because of government ethanol subsidies, which led to record demand for corn. Before that, high energy prices led to an increase in the price of fertilizer and fuel for farm vehicles. That's the backward view. As we can see, the start of the cycle was higher energy prices. Here's the forward view. As I see it, the only thing that goes up after wheat are bagels. They've just gone up. So, rather than conclude that inflation is just gaining steam, I will conclude the opposite. Inflation has peaked.

currency...

Here's the news from Bloomberg. The dollar falls 0.82% against the Pound in a day. Why?
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``There is a general pessimism on the dollar right now,'' said Samarjit Shankar, director of global strategy for the foreign exchange group in Boston at Mellon Financial Corp. ``People are now concerned that the growth outlook heading into next year is on the down side.''
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Consumer sentiment, however, is still above average, at 92.3. Since think the economy is stronger than the consensus, I was going to switch my bet from Pound versus Dollar to Dollar versus Euro and Yen today, in anticipation of a healthy shopping weekend. Now I have another reason to: a 22% profit (using leverage).

I'm pretty sure the economy will be better than the market thinks today. What I'm not certain of is how far ahead they are thinking. One of the risks I see with a change of position is that the market could continue to kill the Dollar for the next month or two on every bit of bad news if it decides to view it as confirmation of an overall trend of a bad U.S. economy next year. This would, of course, mean that all the good news will be ignored. That's a risk that I'm going to have to take.

hee's a great analysis...

I hope that when I analyze something, it makes as much sense as this does.

"A shocking number"

``This is a shocking number,'' said Phillip Neuhart, an economist at Wachovia Corp. in Charlotte, North Carolina. ``The market is going to remain weak well into next year.'' (Bloomberg)

Housing starts are down 14.6% from September to October. There's still a 6.3 month inventory of unsold homes. It looks like housing will be dead for another year.

update...

There just hasn't been much change in my outlook for the past few weeks. I continue to think the market will stay on a roll through the end of the year. This week has brought deflationary news a little faster and stronger than I thought (I was predicting beginning of December). However, It has further confirmed my long-term outlook that inflation will wither on the vine in 2007. I think the economy will have a soft enough landing to keep interest rates from dropping. Long-term (2008 and beyond) I think the inflationary pressure of 2.5 billion consumbers in developing India, China, and Asia will reassert themselves. I think gold will stay between $550 and $700, and oil will fall to $40 a barrel.

CNE...

Bought CNE yesterday at $12.76. At 4.1 times free cash flow, it was too cheap to resist, even though it with PDC it overweights my portfolio towards oil and gas too much for my liking. The distributions will yield 19% (if they don't go up even more). CNE also hedges half their production against lower prices, so oil could fall to $40 for a quarter and they'll probably still grow their cash flow.

oil

Here are some statements from OPEC President Edmund Daukoru of Nigeria as quoted in the Washington Post. After you read what he says, ask yourself "What does this man think about the future price of oil?"

Daukoru told reporters that when OPEC meets in December they will discuss production, "but it looks as if some further mopping up will be necessary."

"The market is clearly oversupplied, clearly oversupplied," he said.

Daukoru described the current price of oil as "low."

The market has easily absorbed a 1.2 mbd cut in production, and prices are still falling.

Short-term outlook

After two weeks of inflationary data, I see another 4-6 weeks of inflationary, recessionary, etc. data. The first two weeks of December will be the top of the pessimistic cycle, and I hope, presents some great buying opportunities. After that, inflation should slide for most or all of next year.

Until December, I am long the Pound against the Dollar (+ 167 bips since the day before GDP was announced), and long options on Barrick Gold (ABX).

I thought about selling United Airlines (UAUA) at $37, but I don't think oil will participate much in this mini inflationary trend, and so far I've been right. When inflation starts to ease beginning next year, crude should drop like a rock.

chasing returns....

It seems that Mongolia is the hot new place for Hedge funds according to Bloomberg. Pardon my ignorance, but if everyone is working so hard, you'd think that Asian hedge funds would do better than 6.2%. This makes me very happy with my practice account. It's up 46% this year. That's not luck. My top two mistakes cost me 20 percentage points (and I still have 46%). Sweet!

conclusions...

1. The Canadian withholding tax on FTE's will increase from 15% to 41.5% for U.S. investors (beginning in 2011 for existing FTE's).

Will these companies change their structure?

2. FTE trusts will no longer be able to deduct distributions. This means that they will pay an additional 21% tax on earnings. For example, Canetic Resources Trust (CNE) has a payout ratio of about 75%. This will reduce overall earnings by about 16%.

Will these companies continue paying their current level of distributions?

specifics...

Canadian tax changes

Canadian Energy Trusts

Canadian energy trusts were down 12-15% today on news of a new tax. Here are the news and the facts as I find them:

Marketwatch posted these articles: "Canadian stocks tumble on tax change" and "Canadians dominate NYSE's top losers list".

Here's what Finance Minister Jim Flaherty had to say in his statement last night.
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The government is proposing to apply a Distribution Tax on distributions from publicly traded income trusts...

For income trusts that begin trading after today, these measures will apply beginning with their 2007 taxation year. For existing income trusts the government is proposing to provide a four-year transition period. They will not be subject to the new measures until their 2011 taxation year.
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Marketwatch said that "the change, if approved, would negatively impact dividends to nonresidents by 26.5%, according to BMO Capital Markets." and "at Desjardins Securities, analyst Peter Gibson agreed and said the draconian measure 'may well mark the end of the income trusts phenomenon.' "