Seems Everyone Forgot About This One

Tim Iacono's blog has an interesting story about Social Security.

Apparently, the estimated Social Security surplus has shrunk from a combined $80 billion through this year and 2010 to $19 billion. This means that unless payroll taxes recover, the government will have to start borrowing (or raising taxes, or cutting benefits) to pay for Social Security beginning in 2011.

This is just in time for baby boomers who've seen their wealth shrink by $20-30 trillion.

This is on top of pension fund insolvency.

This will be good for gold, and very bad for the dollar. When I get a chance one of these weekends, I am going to look for 5 to 10 gold exploration stocks that are not part of any ETF's. I will pay particular attention to companies that have big company backing, and I will put 1-2% positions in the ones I like.

Trade

Buy 5% position in SDS @ $74.74

The Dow is down, but the S&P500 is not. I want to short something, but can't really make up my mind, so this is it.

The Treasuries are moving back in my direction, but I'm still watching them very closely. I believe in this market, profits should be taken much faster than last year. It looks like the action is getting choppier back and forth.

Trades

It's just a feeling, but I think this rally is unsustainable. Also, there's been no corporate bond rally along with stocks. This tells me that the smart money is just chasing the rally and will be out at the first sign of trouble. If they believed that the underlying fundamentals of the economy were getting better, someone would be bidding up bonds for the safety compared to stocks.

Longer term, we have two major problems in the U.S. economy. First, is the insolvency of the financial system. Even after this is fixed, however, we still have the problem of too much debt, which will cause a multi-year balance-sheet recession, a la Japan. We're moving towards fixing the banks, which may cause a nice rally, but even after that's done, we will still be a long way from recovery. Look at the Dot-com bust. The Dow peaked in early 2000, and didn't bottom until early 2003, before climbing 20%+. Today, we're only 1.5 years after the October '07 top.

So, in response to this short term ridiculousness, we have two trades:

Short a 10% position in COF @ $14.83.

COF is worthless in my humble opinion. Back of the envelope calculation tells me that their $178 billion in credit card assets will go from a 6% chargeoff rate to a 9% rate this year if this tracks the unemployment rate (10% is a low estimate, in my opinion). It's actually climbing faster. This will cause $5.3 billion in losses against a market cap of $6 billion. Sayonara!

Buy 5% of EUO (Euro Ultrashort) @ $21.78.

The E.U. is in serious trouble. Their banks are over leveraged, perhaps even more than U.S. banks. They have too much eastern Europe, Asian, and Latin American exposure. Their governments are prohibited by the Maastricht Treaty from having fiscal deficits greater than 3% of GDP. Germany will hit that level later this year or next year. Ireland, Greece, Italy, and Spain are way underwater. They have high debt, high deficits, imploding housing bubbles, and high unemployment. They can cheat on the numbers, but their bond spreads keep climbing. If they can't borrow, they will default, because there's no way out of the Euro.

Treasuries

My Treasury holdings are making me nervous. The 30-year is almost back to where it was when Bernanke announced his collosal money printing plan. It seems to have only been a speedbump in the selloff.

Another worrying sign is the failure of the United Kingdom's 40 year bond auction. They failed to sell the whole amount. The price can still be held down at any particular auction, by not accepting low bids. However, liquidity will dry up and the market will shrink. This is not to say that the U.S. is the U.K., but it is experiential evidence that quantitative easing is a cure-all for enormous supplies of government bonds.

Treasuries did, however, rally into yesterday's stock market downturn. This makes me suspect that some of the Treasury weakness is due to the market upturn encouraging risk-taking activity. However, I've noticed that when the market is down, Treasuries go up, but not as much as they go down when the market is up.

Part of me says, "take the loss and get rid of the risk." The other part says that this is just risk taking activity, be patient, and wait for the employment report (better known as the UNemployment report) on April 3rd. I think I will do this.

I was seriously considering trying to short the Japanese Yen today. Their economy is in a huge tailspin, with exports down a record 49.4% over February of last year. However, FXY is hard to borrow. Japanese government debt, unlike U.S. debt, is mostly held internally. However, my thinking is that without a sizeable trade surplus, they will be unable to finance their fiscal deficit, which is 1.70 times GDP. It's not foreign owned, as U.S. debt is. If they had to borrow from foreigners, they would have to pay higher interest rates, and the Yen would plunge. I guess I will keep an eye on this and if I want to do it in the future, I'll have to short the Nikkei index, or come up with some other creative solution.

Trades!

First, a word about Tim Geithner's ponzi scheme to loot the taxpayers in order to enrich government cronies and wealthy well-connected people. Paul Krugman explains it better than I can. All I can add is that it remains to be seen how to bridge the gap between the 30 bid and the 80 ask on most of the toxic crap on bank balance sheets. What this really is, is a payoff to both the banks and the hedge fund industry.
The FDIC is being used as the conduit to funnel money to the banks through non-recourse loans to hedge funds and other asset managers.

On to my portfolio: unfortunately, today I got killed on my international shorts, which have rallied very strongly since the recent lows in U.S. stocks. I'm afraid that Bernanke's devaluation of the dollar has caused a flight to other markets. I didn't see that coming.

Trades:

I couldn't resist selling into this rally, so I closed SFL and shorted homebuilders and oil.

sold SFL @ $6.97, +60%
sold short DIG @ $25.18
sold short KBH @ $12.93

I sold SFL because $7 was my target price, based on book value.
I sold short DIG because I wanted to short oil here. I think that shorting the ultralong will give me a return, not just for a drop in oil prices, but also for a drop in price volatility.
I sold KBH because of the drop in home prices, which was much bigger than the jump in sales. Overall, the market is still shrinking rapidly.

Fire Up the Helicopters!

Helicopter Ben has fired up the helicopters and the printing presses! In a shocking announcement today, the Fed will buy $300 billion in Treasuries and $750 billion in agency mortgage bonds. Not surprisingly, the 30-yr. was up 6.1%, and the 10-yr. up even more at 15.6%. Gold was up 5.5%, along with equities and oil as well. The dollar was down sharply agains the Euro. The ECB is the only major central bank that isn't (yet) monetizing. Japan and the Bank of England are already printing money.

Ben Bernanke is obviously very frightened by last month's net selling of Treasuries and other bonds by foreign holders. Well, if they need to sell, why not print up some new bills and buy it back cheap? Win-win. Or is it?

Here are some unintended consequences I'm going to look for. First, I think corporate bond yields will rise. Second, with the Fed buying Treasuries, many people looking for safety will jump into Treasuries now that they don't have to worry about a collapse in Treasury prices. Another consequence, perhaps intended, will be a weaker dollar. This will put more pressure on the major exporters of the world: Germany, China, and Japan. I will continue to think more about this, as I think this could be a fertile field.

Hope for Taxpayers!

There is hope for taxpayers today, as bankruptcy judge Michael McManus rules Vallejo can void union contracts. The judge ruled in favor of the bankrupt city ruled that municipal workers do not enjoy the same protection as workers at private companies.

This looks like the solution to the $2,000,000,000,000 needed to fully fund pension funds.

Brilliant Analysis of Chinese Economy by Michael Pettis

Michael Pettis has a great story today on SeekingAlpha. Here's the juicy part:

By the way, this exercise should indicate yet again why all the discussions and debate in China and the US – about whether or not China should continue financing the US fiscal deficit – are wholly beside the point, as I have been arguing almost mono-maniacally for years. China cannot finance the US fiscal deficit, nor can any other country. China can only finance the US trade deficit, and it must do so by recycling its current account surplus, either via Chinese investors, or via central bank purchases of US dollar assets.

If there are hot money outflows from China large enough to cause the central bank to lose reserves, the central bank will not only stop buying US Treasury bonds and/or other dollar assets, it will have to sell something, which is most likely to be US dollar bonds. It has no choice.

Hmmmm.... So, let's put on our political economy caps and think about what this means for Treasuries. Overleveraged European banks are dumping U.S. assets, and Chinese investors, apparently, are selling Yuan for dollars to buy them. This means that the CBOC is probably also selling Treasuries or other bonds. Bernanke, meanwhile would love to start buying Treasuries. China would love to wait until Bernanke starts buying to start selling even more. In the end, though, does it really matter? China will sell, and Bernanke will buy. China will pay off their debts, and Bernanke will monetize ours.

However, there will be unintended consequences. First, if Treasuries are kept artificially low, that will push yields higher for everything that's more risky: mortgages, corporate bonds, muni bonds, and everything else. Gold, I think, would especially benefit. Also anything Chinese investors getting their money out of the country want to buy. If they're thinking long-term, it'll be commodities.

A net outflow from the central bank has to be financed by retiring central bank bills or “destroying” RMB. This implies monetary contraction, and it is still difficult for me to see how this would not have a contractionary effect on underlying money.

This is the reason I'm bearish on China over the next couple of years. They could easily go into a depression if their trade surplus goes negative.

Looking at PWE

Reasons to buy PWE:

1. Natural gas is at $3.83, the lowest in years.
2. 45% of U.S. natural gas rigs have been shut down since September. This covers 5.2% of production, while demand is down 1.9%. There's a big cushion here.
3. PWE has good management and is consolidating the industry
4. 25% dividend, which is easily covered by cash flow at $45 oil and $5.50 natural gas
5. No debt due until $2.5 bil in 2011.

Problem is that the favored tax status goes away at the end of next year. However, none of that matters if we get a couple of nice big hurricanes this year. I'm thinking of going long a 5% position.

And what about Treasuries? There is lots of data out there that foreign banks and countries are dumping U.S. assets. European banks used a lot more leverage than U.S. banks, and most of their funding was in dollars.

Including the Fed, the U.S. was a net lender to the rest of the world last quarter. I don't see how China can continue to buy Treasuries if they don't have a trade surplus with us, and that is vanishing rapidly. The wild card, however, is whether Bernanke starts to buy Treasuries.

Disaster or Opportunity?

Since the beginning of February, when President Obama announced his intention to institute a carbon cap and carbon trading, the utilities have sold off by 20-40%. Everyone's afraid of the increased costs that will be hoisted onto the utilities. Will this be a disaster for the utilities?

Let's look at some other industries that suffered "disasters."
What about oil tankers after the Exxon Valdez disaster?
Or cigarette companies after the government lawsuit?

Were these "disasters" or opportunities?


The big news today is that Congress is considering legislation to do away with mark-to-market accounting. If this happens, it will be very bullish for banks short-term. Long-term, the picture is cloudier. I personally think that a good compromise would be to eliminate mark-to-market and tighten off-balance sheet loopholes to bring much of that back on the books. However, it is still possible that the elimination of mark-to-market accounting will not change much. It may eliminate some distressed sales of MBS and CDO's, but it may not make banks more willing to lend.

News Crumbs

China's exports for February: - 26%. Imports were down -24%. The trade balance was +$5 billion, down from +$39 bil in Janruary and $8 bil a year ago. Don't tell me China's bouncing back. This could also be what has been pressuring the Treasury market recently.

Deflationary news is just everywhere; it's just too much to mention. Bank credit is contracting at a 2% annual rate. However, there is even worse news. Consumer credit expanded last month, with credit card balances mushrooming at a +25% annual rate over the last four weeks. No wonder banks are cutting back balances. It looks like people are running up the balances again, and in this economy, it's not because they're doing well.

Inventories in almost everything (except maple syrup) keep rising as a percentage of sales. Credit conditions remain tighter than ever, with the NFIB survey showing 13% of business owners say it was harder to get credit, the highest % since 1981. Plans to boost prices and wages are at all time lows.

With that in mind, I'm going to keep my eyes open for an opportunity to short oil again, or maybe even credit card related co's: COF, JPM, BAC, DFS, or AXP.

And this story from Bloomberg about how Banks' Bondholders May Be Next in Line to Share Bailout Pain makes me bullish on gold and bonds and bearish on stocks again. Bond yields for bank stock including C and BAC average 8.21%. Citi's almost $800 bil of 7.25% bonds due October 2010 are yielding 9.4%.

The Euro doesn't look so strong after this news: German manufacturing output vaporized by -38% yoy. As the country with the second largest trade surplus (last year) after China, this is no surprise.

Trade!

Well, I'm buying today. First order of business is to close DUG. It's trading 20% higher than net asset value and is spiking today, even as oil climbs. PXE is also trading off NAV, at -15%. I will cover this position as well. Last order of business is to do some bargain hunting, so I will take a half position (5%) in SFL. The market is pricing in a high probability of a negative credit event such as a breach of loan covenants or a plunge in tanker rates over the next few months. Both of these things may happen, however, management is excellent and is reinvesting dividend proceeds back into the company. Target on this is $7.00, or about book value. Things can change real fast, though, so I will watch this like a hawk.

Sell DUG @ $35.17, +5% return
Buy to cover PXE @ $10.04, +26% return

Buy 5% position in SFL @ $4.66

Trade

Sold SDS (S&P 500 Ultrashort) today. Unfortunately, I bought it on the November 20th lows, and I'm taking a 2% haircut.

This trades more with the volatility index than the S&P. I just don't see volatility going back, even to 60. Take today, for example. The market takes a 281 point, 4.09% bruising, and the VIX is +5.5% to 50.27. It's just not jumping that much. I'm also getting a little nervous about being so short when the market is ignoring good news.

I'm also thinking of closing my DUG oil ultrashort. With gasoline demand up yoy for the past three weeks, maybe this is as low as oil goes. On the other hand, maybe I'll short more PXE, for two reasons. First, the Obama administration is anti big oil, and second, the oil companies will have big problems if the long-term price of oil keeps falling.

TALF

TALF stands for Term Asset-Backed Securities Loan Facility. This is Tim Geithner's and Ben Bernanke's much hyped $1,000,000,000,000 thingy that was supposed to fix the banks, and boost consumer borrowing and auto loans. Unfortunately, nothing's happening with the TALF. In fact, the $500,000 limit on compensation for bank execs has disappeared from the TALF agreement, which was revised March 3rd. So far, no bites. Not a nibble. So, my question is:

If you have a $1,000,000,000,000 lending plan, and nobody wants the money, how much is lent out?

Also, the TARP is now down almost $112,000,000,000. Taxpayers, pull out your wallets.

I do see one ray of sunshine today, and that is that the market is down 200 on a day when retail spending was +0.7% instead of expectations of -1.1%. I think one sign of capitulation is when the market starts ignoring good news. And one other thing: gasoline usage is now up for three weeks in a row. Perhaps the consumer has made some headway repairing his/her balance sheet. I'm not ready to go long yet, but I think I should close a short today, maybe sell SDS.

In another shocking, SHOCKING, development, China declined to announce any additional stimulus. Instead, they announce expected GDP growth of 8%. The market was disappointed, to say the least. In other news from China, Over Two-Thirds of Chinese Economists Favor Gold Over US Bonds. 33% actually believe that China should sell US bonds. Here's the interesting part. I like this guy: "One economist thinks China’s current gold reserve of 600 tons is an unnecessary load and that the opportunity should be grasped to sell off a bunch of it at a good price."

On the other hand, one in five US homeowners who now owe more than their house is worth.

Another tidbit comes from England, where they keep track of hedge fund leverage. This number has dropped to 1.11X. This may not be bearish, however, it's not necessarily bullish either. It's just a sign that forced selling and extremely high volatility (such as VIX over 60) is probably going to go away.

AIG

I'm looking at the market action today. Dow, up 130. RIO +10%, FCX, +13%, DRYS, +28%, CLF, +12%, SFL, +10%. This is not sustainable, in my opinion. Also, the bank stocks are mixed or down. I don't see how we can have a sustainable recovery without fixing the banks. They are core of credit, and therefore the lifeblood of our economy.

In other unbelievable news, China is preparing to announce more stimulus. Since the world bought the last charade, hook, line, and sinker, why not? Although now there are calls for China to double or triple the last number (that's all it is). With expectations that high, they can only use this one once or twice more. Also, wealthy Chinese are looking to get their money out of the country. How? They're buying homes in Southern California, of course! You don't think they're investing in their own economy now, do you? Pffffff! Of course not. They know what's going on over there. Steel inventory at the port of Shanghai has risen 44% so far this year. This is what happens when you build dozens of empty buildings and suddenly stop.

At the end of 2008, AIG still had $302 billion in credit default swaps outstanding. Every time they are downgraded by the ratings agencies, they will have to pay out more. And don't forget, they have a huge exposure to commercial real estate, which is dripping like a dead squirrel out of a reeeeaaally tall tree. Ouch! Bounce! Plonk! Thud! They're gonna need another $150,000,000,000 at least. Maybe that'll last them until the next hurricane or earthquake and then they'll need another $30 bil.

I'm still thinking about bonds. Treasuries seem to be retreating slowly. However, I need to be careful, because if they can't show any strength soon, it could turn into a rout. Another thing I'm considering is shorting the Yen. Even if there's a bounce or a floor from the fiscal stimulus in the U.S. and China, will that help Japan? Can Chinese afford expensive Japanese products? I don't think so. And we're not going to increase consumer spending any time soon. Japan's stuck in the middle. In addition, they have enormous demographic problems because they don't have children.

I was just wondering what effect the TALF would have... It shouldn't have that much on the 30-yr. We shall see. I need to watch this one closely.

Time to Trade!

ABX has dropped almost 30% since I bought it, with a 15% drop in IAG. I'm going to sell IAG and roll over the position into ABX.

EUO - I am going to get aggressive here and buy this at $25. The Euro nations completely denounced any bailout for eastern Europe over the weekend. Who can blame them? They have their own problems - economic forecasts are for Ireland's GDP to shrink by 20%. However, if eastern Europe defaults, it will be western Europe's banks that will be left holding the bag. Talk about shooting yourself in the foot. What I do expect to see is aggressive cutting by the ECB, as inflation is now under 2% at 1.8%. This will cause the Euro to weaken, possibly to par with the dollar.

Though it leaves a bad taste in my mouth, I'm going to sell FRO here with a huge loss. I should have sold it at $25, but I didn't. The reason I bought it, the oil price contango encouraging tanker use as storage, is gone. That's why I bought it, and there's no reason to hold it now. As the contango disappears, all those tankers will come back on the market. In addition, the fleet is supposed to grow 10% this year, which is a scary thought.

Trades:

sell all IAG, +65%
I also sold the OZN that was rolled over into IAG for a weighted average of +39%

buy 10% position, ABX @ $29.20.
buy 10% position (20% including ultrashort leverage), EUO @ $25.36

sell FRO, -37%