Whoops-a-Daisy!

I usually would rather learn about something by doing it. Don't read instructions, don't ask advice, don't take classes, don't research.... Just Do It! Well, I'm not actually that extreme.

However, that pretty much characterized my first foray into the bond market earlier this month. I bought $3,000 of 2-yr bills. My thinking was that the bills would strengthen with a flight-to-safety trumping the bad fundamentals of massive supply. A low VIX/fear index showed me that there was plenty of room for sentiment to turn frightened.

My rough idea was that if the yield fell from 2.91% to about 2.5% I would make about 15%. While my timing over the last three weeks was impeccable, my calculations were moronic. That's not how you calculate profit on bonds. The 2.91% was a yield-to-maturity calculation. The change in bond price determines profits (aside from interest). I closed the position today with the two-year yielding 2.62%.

Here's how the calculation works: the underlying price of the bond rose 0.29% as the yield fell 0.29%. So the profit on $3,000 worth of bonds was 0.0029 X 3,000 = profit gained per year of interest paid above the current rate = $8.70. This was a 2-yr Treasury, so profit was $17.40.

Measly. And that's why I sold this bond (gaining just over 2% including interest) and bought $6,000 in 30-yr Treasuries. The VIX still has a long way to go. The dollar is being supported at these levels. And finally, unemployment is announced on Thursday. Each bip (basis point, 0.0001) the yield drops, is an $18 profit (or loss if bonds sell off.)

This position gives my portfolio an overall duration of 5, instead of 0.34. If I had started off with my new position, I'd have made $468 instead of $17.

I can't complain. I just made $17 to learn how to speculate on Treasury bonds.

UBS in Trouble

"UBS considers Paine Webber sale in review: sources" - Yahoo! Finance.

Here are the juicy details:

UBS is under pressure from the Swiss financial watchdog and from one of its top shareholders, Olivant, to overhaul its business after more than $37 billion in writedowns during the credit turmoil.

Translation: regulators are telling UBS to raise more capital, because they're broke and they have more write-offs coming. This is another step down the road of capital getting harder and harder to raise. UBS is now being forced to sell of its good businesses at low prices while the losses get clustered in the remaining and weaker businesses. UBS is out of suckers to sell more equity to.

Housing Market

I told my brother that the time to buy a house in Ventura County would be 6 months after Countrywide goes bankrupt or lays off half their employees.

That should be about a year, year-and-a-half out now, judging by the headline "BofA to cut 7,500 jobs after Countrywide deal".

Look out below!

Trades: with the DOW sinking like a lead balloon and GS issuing high-profile "SELL" ratings, I knew it was time to buy. So I closed 3 positions:

1. RIMM - held for one day for a 13% profit.
2. SKF - Ultrashort Financials sector - the financials have not been so low since the Bear Stearns collapse in March.
3. PHM - My smallest homebuilder position, and perhaps my most profitable. Originally, Pulte looked like they would have serious trouble refinancing debt due later this year and next. They still may, but their cash flow is holding up better than expected, they've refinanced a couple of bonds already, and today is a good day to buy.

What a Busy Day!

Mish: Vietnam world's biggest importer of gold bars on inflation fears. Instead of stopping the money printing, the government is now banning the importation of gold. One more reason to buy. However, if I was holding bullion, I'd hold it in Switzerland. The next thing the government will do is confiscate it.

AMZN - I'm thinking of covering my short position at a small loss after listening to Jeff Bezos being interviewed on NPR last night. The guy is brilliant. He was questioned abou how Amazon would respond to increased shipping charges from high oil prices. Jeff eloquently explained that high gas prices help, not hurt Amazon. It's so expensive to drive that often it's cheaper to ship something small, which is their business anyway. But their P/E's still at 65... I will hold them for now, but as soon as I find something I like more, I will close this one out, even if it's at a loss.

Trade: OZN - more gold exposure. OZN has fallen to only 2.5% of my portfolio and I still think it's a good company, so I bumped that up to 3.5%.

Obama says we need more stimulus checks. WOW! I guess that's what he means by CHANGE! I guess he's so impressed with how the previous ones worked... There goes the dollar.

Here's Why I Don't Trust the Official Numbers

Trust this?

A case in point is the Evergreen Ultra Short Fund, which just closed this
week... Just recently one of the fund mangers was offered a bond, which is
a matching position to current holdings at a price of 23, that is 23 cents on
the dollar. Great value yet the fund manager was in a pickle and decided
against purchasing the bond at such a cheap price. Why? As the fund
manager said it would create an issue with his mark on the bond that was
currently being carried at a dollar price over 95, or 95 cents on the dollar,
yet at that point he knew what his bond was worth, yet choose not to challenge the pricing service and its assigned value. The bond ended up trading that was offered to the Ultra Short fund manager to another account at a price of 9. The buyer was Tattersall, another subsidiary of Evergreen, yet the bond at Ultra Short was not remarked to the downside.

Special thanks to Reggie Middleton's BoomBustBlog for this one! It's a little hard to understand, but I think this is what he means. The fund manager is holding a bond carried on the books at 95. But it's not really worth 95, as a trader calls and tries to sell him a the same bond, but at 23. The fund manager says, "that's a great deal, but no thanks. If I buy it, I'll have to mark my other bond down from 95 to 23."

Bloomberg reports:

Evergreen Investments, the money- management unit of Wachovia Corp., plans to liquidate a $403 million fund with almost three quarters of its assets in mortgage-backed securities after it fell 18 percent this month.

Trust this? No, thank you.

Trades

Sold RIMM short at the open. They're supposed to report earnings up over 100% later today. We'll see.

Sold BCS short today. They're diluting shares by 20% while paying a 14% dividend. The shares jumped 5% today. See Bloomberg.

Wait til they cut the dividend.

Brilliant Quote!

I found this gem yesterday:

There is a large and vibrant truck market out there, it's just a lot smaller than it used to be - Mark LaNeve, GM Vice President of North American sales.

I'm laughing my ass off. Large, just a lot smaller. Unfortunately, there's just no way to spin this disaster. GM better plan for their truck market to keep getting smaller. It's time to give up market share for survival.

Soon, the rest of the world will slow down sharply along with the US. The Baltic Dry Index is plunging. The index usually shows seasonal strength, rising from May through November. It's highly unusual for the index to plunge 20% in a month. See Capital Link Shipping for charts.

Short US equity exposure shrinking

My short US equity exposure is shrinking. I closed my UBS short today at $21.96 for a 3-month 33% gain. I believe that UBS may very well fall much more over the next year. They will have to write down billions more due to monoline insurance co's losing AAA status. When they raise money to replenish capital, it will be highly dilutive. However, there were two very good reasons to cover today. First, the size of my position was only about 4% of my portfolio. Second, European banks hit four-year lows today, led by UBS. There won't be a better buying opportunity short term.

Two options expired today: a MCGC 12.50 call and a C 20.00 put. The call expired worthless, while the put expired $0.79 in the money for a nice gain.

At the close today, my position breakdown was as follows:

Short US equity: 65%
Long forex: 22%
Debt: 20%
Duration: 5 months
Long international equity: 18%
Long US equity: 11%
Short International equity: 9%
Options: 2%
Cash (available to trade without borrowing): 17%
Short forex: 0%
Long commodities: 0%
Short commodities: 0%
Leverage: 1.47X

Short US equity is down from 109% on May 28th, due to closing WM and UBS and paper profits. Leverage is down and cash available to trade is up.

More Info

According to BankUnited's most recent quarterly report, they had deposits of $6.9 billion. Just wondering if the FDIC is ready.....

They're Done! Time to Take this Turkey out of the Oven!

BankUnited (BKUNA) Florida's largest bank is raising (translation: praying for suckers to help them) $400 million, according to this Press Release. There's just one problem: BankUnited's market cap has fallen to $65 million from almost $800 million a year ago. It's a little too late to raise capital now, as the impending dilution has dropped the stock 47% since Tuesday's close.

Time to take this turkey out of the oven!

So, the question is what cooked this bird? Subprime lending? NO! It's those just-now-exploding arm-neg-am loans. These brilliant financial inventions account for over 50% of their lending portfolio.

Thanks to Option ARMageddon for this analysis:

[Negative amortization option ARM's haven't] hurt the company’s “profits” however. Each month the bank is recognizing accounting profits on "payments” that borrowers aren’t actually making in cash. It’s as if your credit card company recognized a full $1000 of income even though you only paid ‘em $10. We see this in action on the annual cash flow statement, see page F-6 of the company’s proxy filing. The company’s TOTAL net profit in 2007 was $81.4 million. But that included over $181m of “negative amortization,” the accountants’ fancy word for “income” that wasn’t actually received in cash.

Current commitments of traders -
http://www.softwarenorth.net/cot/current/charts/CL.png
- shows low speculation.

Spot tanker rates -
http://www.intertanko.com/templates/Page.aspx?id=18831
are currently 242% higher than last year's average, and so far this year are averaging 127% higher than last year's average. This shows me that someone's hoarding oil on tankers. We know Iran is. Who else is?

Another interesting fact: the oil that Iran is storing usually goes to Asia. Is demand from Asia falling? Are Asian refineries buying easier to refine oil because of a supply glut? Or is Iran squeezing the market to drive up prices as international pressure is applied to force suspension of their nuclear program?

Will falling demand in the US and Europe offset dollar weakness?

OooooWoooooHooooo! Scary!

This is the first thing I saw this morning: Inflation jumps by biggest amount in 6 months. Next came this subtitle: "Inflation soars 0.6 percent in May, reflecting biggest jump in gasoline costs since November." While the article seemed balanced, my first thoughts were cynical. Bernanke talks tough and voila! out come the highest inflation numbers in 6 months. Balderdash! What good's talking tough if you don't have a monster to fight? A scarrrrrrry, scaaaaaaarrrry, monster. Boo! Scared you didn't I?

Ben's the one who's really scared.

Hedging, Investment Bank Style!

From the New York Times comes a fascinating, although unsurprising view into the inner working of Credit Default Swaps. Apparently, at the beginning of last year, UBS found that they were going to get stuck with subprime CDO's that they didn't want to take losses on. So they looked around for a sucker to stick it to. And they found one: Stamford, Connecticut based Paramax Capital. It didn't matter that the CDO UBS wanted insured was $1.31 billion and Paramax only had $200 million. UBS just wanted to list the CDO as "insured" so that they wouldn't have to write off losses. Paramax must not have been so sure, as the deal stretched on for a couple of months. If only Paramax had gotten this gem in writing:

During a Feb. 22, 2007, phone call, Paramax contends in the filing, it was
informed by Mr. Rothman that “UBS set its marks on the basis of 'subjective’ evaluations that permitted it to keep market fluctuations from impacting its marks.” The filing also says: “Rothman explained that he was responsible for all marks on UBS’s super senior positions and that he could justify ‘subjective’ marks on the Paramax swap because of the unique and bespoke nature of the deal.”

My note: the above quote is not a typo: "subjective" as in not objective is correct. Apparently, Mr. Rothman's promise to commit fraud on behalf of UBS sealed the deal. After all, these were AAA rated "Super Senior Tranches." After getting burned for $30 million through November, Paramax stopped paying UBS, and when UBS sued for breach of contract, Paramax countersued, claiming that due to Mr. Rothman's assurances, UBS had broken the contract by marking the CDO to market. It's so beautiful, it almost makes me want to be a lawyer.

In the investment world, this is called "Hedging."

Fascinating!

It seems that hot money inflows into China are even bigger and more complicated and ingenious than I had supposed. First, I will quote the article that enlightened me. It comes from Michael Pettis on Seekingalpha.

With appreciation pressures so strong, it is pretty clear that various forms of hot money have become the engine of money creation. It used to be the trade surplus that powered reserve growth, but the unexplained amount – after the trade surplus, FDI, currency valuations, interest income and all the other easily explained things are removed – is now by far the biggest
component of reserve growth, and even this understates its impact because there is increasing evidence that a large and growing part of FDI and the trade accounts are also simply disguised hot money.

In other words, investors buying yuan are pouring foreign money into China. The central bank continues to print yuan like crazy to buy up all the foreign money. This is one of the biggest factors in global inflation today.

In this context, one of my eagle-eyed readers sent me a link to this fascinating article from today’s Dow Jones Newswire:

SOFIA (Dow Jones)--Copper has become an instrument by which hot money flows into China but this has created the false impression that Chinese consumption has taken off, Wu Yuneng, general manager of JCC Southern Group Company, said Wednesday. Noting that investors are looking to capitalize on interest rate differentials between the renminbi and dollar, Wu said copper is being used as a tool for foreign exchange gains.

China's economic growth is a sham. It consists of importing raw materials and exporting printed yuan.

Financing and foreign exchange arbitrage means that copper cathode imports are large even when the arbitrage between the London Metal Exchange and the Shanghai Futures Exchange is negative, Wu said, speaking through an interpreter at the Metal Bulletin copper conference in Sofia.

Chinese traders are willing to lose money by buying copper for more than it's worth in London because they more than make up for the loss with profits on the currency exchange.

Evidence for this copper financing play can be seen in data from the Chinese Commerce Department, he noted. This showed Chinese foreign exchange reserves in the first quarter amounted to $1.68 trillion, an increase of 40%. Even accounting for a net surplus of foreign trade and foreign direct investment, $85.1 billion cannot be explained, said Wu.

China is printing $480 billion per quarter. If this sounds like a lot, it is. What does this really mean? This can be viewed as a measure of the pressure on the yuan to rise. If there was no pressure on the yuan, they wouldn't have to print any more to stabilize the value, would they? What might this look like quantitatively? How much should the yuan rise against, say, the dollar? Just look at oil.

Essentially what is happening is that commodities are being used as a medium of exchange for different currencies. If this sounds bass ackwards, it is. The way to play this is long yuan, short Chinese equities, and long commodities. I've got two out of three. The third, commodities, requires some waiting. (It's also the most dangerous play because it depends the most on the lie for its survival.) A regulatory clampdown on speculators should provide a golden opportunity to jump on the bandwagon. The time to buy will be a month or two later, when prices have flattened for a month or so.

Speaking of which, one of my investment strategies is to re-read everything I write a month later, at which time whatever trade I was considering shows some of the benefits of hindsight.

Update

First of all, I closed WM today at $7.00 for a 40% gain in under three months. Although they bounced up from a close of $6.25 yesterday (which I missed while out getting lunch) they pretty much collapsed over the past two trading days. Also, my WM position was less than 5% of the Obfuscation Fund at yesterday's close. Even if it fell another 20%, it would contribute much less to the bottom line.

Another thing I want to comment on is the trade deficit. Despite being in a recession, the trade deficit jumped in April to a 14 month high, according to Bloomberg:

The gap grew 7.8 percent to $60.9 billion, more than forecast and the most
since March 2007, the Commerce Department said today in Washington. Excluding petroleum, the shortfall was little changed.

...

Imports grew 4.5 percent in April, the biggest gain since November 2002, to a record $216.4 billion. The average price of imported petroleum, at $96.81 a barrel, and the total amount of the fuel bought, were both the highest ever.

In other news, Chinese regulators surprised the markets by raising bank reserve requirements a surprising 1% to 17.50%. They are trying hard to put the brakes on their economy. I will be watching closely for their inflation numbers. Another thing that may put downward pressure on the Shanghai bourse is this years biggest IPO coming up.

Finally, I think I've found an opportunity for an interest rate play. The two-year Treasury yield is now at 2.89%, as the markets expect a couple of quarter point raises by the end of this year. I can't imagine that the coming wave of bank failures along with soaring unemployment will allow Bernanke to raise rates. The major banks are all finding it harder and harder to raise capital. I can't wait to see how much of a discount Lehman needs to give in order to raise the $6 billion that they plan on. Incidentally, since their market cap is now around $7 billion, this will be about an 85% dilution. That's almost as bad as the National City (NCC) deal, where they had to offer a 30%+ discount. Essentially, that 30% discount allows the buyers to just turn around and sell their shares on the open market, subject to the drop in price that all those extra shares for sale causes. NCC's stock is currently at $4.77. It's so low that it will be almost impossible to do another deal. Here's how the CEO explained being put on probation by bank regulators:

Peter Raskind, National City's chief executive, said that the company won't release precise language of the agreements with regulators, but he reassured investors that National City now qualifies as having "the highest Tier 1 capital ratio among large banks in the United States." - Marketwatch

Unfortunately, we've heard this before. But as long as there are fools to believe them, they'll keep lying. NCC has $153 billion in assets. If they go under, they'll probably take the FDIC's puny $50 billion out with them. Nothing like a good old panic to reverse this ridiculous sentiment that Bernanke will raise rates. I'm not saying that he won't raise rates, just that I think it's more likely that he'll lower them. He is Helicopter Ben, after all.

Back to my idea about buying 2-year Treasuries. I will have to decide whether to buy the bonds themselves, or to buy an option on SHY (iShares Lehman 1-3 Year Treasury Bond index ETF). They're asking $1.05 for a Dec $82.00 call. With the current price at $82.35, I think that's a steal. SHY doesn't move much though: the 52-wk. range is $79.64-$84.61. I will need to call Schwab and find out what the terms of buying 2-yr. T's is. Then I will decide how to play this.

Bank Research

In this post, I will show the research I have done pursuant to my idea that I should short common stock with high dividends that will be shorted as a hedge by preferred stock buyers when the dividend drops. Here is what I looked at:


Bank: Preferred Yield: Common Yield: Short Interest: 52-wk. High/Low: Current Price: Bounce from Low:

Regions
Financial (RF) 9.0% 8.5% 7.2% $17.21/$35.91 $16.68 0%

Citigroup (C) 8.5% 5.8% 2.2% $17.99/$54.49 $21.42 19%

Fannie Mae
(FNM) 8.25% 5.2% 10.7% $18.25/$70.57 $26.72 46%

Freddie Mac
(FRE) 8.25% 3.9% 10.7% $16.59/$67.68 $24.58 48%

Merrill Lynch
(MER) 8.63% 3.2% 4.2% $37.25/$92.93 $41.89 12%

Key Corp. (KEY) 9.0% 7.7% 3.2% $18.89/$37.09 $18.74 0%

Fifth Third
(FITB) 9.0% 9.4% 6.1% $17.91/$43.20 $17.35 0%

National City
(NCC) 12% 0.7% 18.6% $5.44/%35.12 $5.55 2%

Wachovia (WB) 7.5% 6.3% 6.1% $22.72/$54.54 $21.92 0%

WaMu (WM) n/a, # 0.4% 18.3% $8.72/$44.60 $8.75 0%

Sovereign Bankcorp
(SOV) n/a 3.5% 6.5% $6.48/$23.35 $9.23 42%

Bank of America
(BAC) 8.125% 7.5% 1.5% $33.12/$52.96 $33.31 1%

# - latest offering was a below market price private offering of common shares. I guess this is what happens after the dividend is cut and there's no money to pay a yield.


Analysis

Actually, it looks like I missed the boat here with the best-looking stocks (RF, KEY, FITB) all at their 52-wk. lows. C, FNM, and BAC look fairly good, but I've already gotten two out of those three.

Conclusion

I checked where National City was at when they cut their dividend: $8.33. The time to sell these off is when they announce their dilutive offerings. WaMu jumped 30% on a short squeeze when they announced that they had been rescued by a $7 billion bailout including a common share private placement at $8.75. Guess what? That's where they closed today. I'm close to taking a profit on this, but I'm waiting for some more fear in the market.

I Just Realized...

...Why Citigroup (5.80%) is still paying huge dividends. It's so simple, I don't know how I missed it. When a company comes out with a preferred issue with a high yield, like Citi at 8%+, it's a great trade to buy the preferred and short the common stock, which provides a very good hedge.

So the answer is still the obvious one: they're supporting the stock price. However, the dividend is supporting the stock price much more than normal. If C is forced to drop their dividend, they will make it much more profitable to buy the preferred and short the common stock, as the whole preferred dividend would be the expected profit, instead of just the ~2.5% spread.

This gives me an idea: go through financial stocks and make a list of companies selling preferred stock while maintaining excessively large dividends. Close the position after the dividends are cut.

I also have some other investment ideas that have been rolling around inside the old noggin over the past month or so.

1. I've been watching oil. I'm thinking that if it pulls back to around $120, I may short DUG (Proshares Ultrashort Oil and Gas) as a play on oil rebounding against a renewed dollar plunge. I still think that the dollar has another leg to fall. I also think that short dollar plays will be very profitable with the overwhelming consensus opinion that the dollar will rebound the rest of this year.

2. Potash Corp. (POT). This fertilizer company is a play on grain prices. It's a Canadian company. I'd consider it if it pulled back to below the 50-day moving average, currently about $180. But it's much too high at $212 now.

3. I'm also thinking about taking a position on interest rates. Two years ago, this was one of the most profitable things I did on my Yahoo! practice account. There are two ways to play this. I can go long with Schwab, but I need to open at least a $25,000 position. Right now, I don't want to use that kind of leverage. I think that rates will take another drop in the next few months, but over the next year or two, I think that bonds will crater and yields will pop. I can also use 2x leverage through TBT (Ultrashort Lehman 30-yr. Treasury index). I missed a nice opportunity to short TBT last week when the 30-yr. hit a yearly high of 4.80%. Bonds haven't been this low since last October, whent the stock market was hitting its all-time highs.

Burnout!

China's economy has overheated. The March inflation report most likely will show higher inflation than growth. No one can deny that inflation is accelerating while growth is slowing. China has gained as much as their economy can from bringing ever more cheap labor to the local market. Now their wage inflation will force a dramatic transition in their economy. But this list is just the beginning of China's problems. The Szechuan earthquake will amplify near-term inflation pressures, just as Hurricane Katrina did in the US. In the meantime, the icing on the cake (or the haystack on the camel's back) is the inflow of speculative funds betting on the Yuan's appreciation. This foreign currency inflow is now so huge that it's making the export business look like small potatos.

Out of this big picture view comes news (from Michael Pettis on SeekingAlpha) that the government is attempting to manipulate the stock market.

According to Saturday’s South China Morning Post:

"For the second time in three weeks, the mainland's stock market regulator has told fund managers not to dump shares. And this time, it says they could be punished if they don't comply.

The China Securities Regulatory Commission said mutual funds should support falling stocks, even though other investors were selling their holdings amid the slump in the nation's equity markets. With concerns rising about the deteriorating economic conditions and with the authorities having so far failed to stem the slide through market-boosting measures, Beijing is now resorting to threats in an effort to maintain so-called market stability.

I believe that this is a desparate attempt to reverse what has become a self-reinforcing marging-call based avalanche. In my mind, this shows that the authorities have come close to losing control. Because this story has been widely circulated, it will make matters much worse. First of all, it gives non-mutual fund stock owners a strong incentive to beat the mutual funds out the door. Second, it will cause a panic among mutual fund holders to redeem their holdings. This will force the mutual funds to sell eventually anyway. As I predicted in Janruary, I expect a collapse in the Shanghai stock market before the Olympics.

Unfortunately, the Hong Kong listed shares have not followed suit downwards. If they don't, then I'll have to be content with moral victory. However, just as they lagged the "A" shares on the way up, it's still possible for them to fall even more.