Seadrill just issued the following news report:

Hamilton, Bermuda, July 30, 2010 - Seadrill has been awarded a six months contract extention for the ultra-deepwater semi-submersible drilling rig West Hercules by Husky Oil China Ltd. The estimated value of the contract extention is approximately US$90 million. The extention secures continued employment for the ultra-deepwater unit offshore China until May 2012. Husky Oil China Ltd. has the right to extend the assignment by another six months on the same terms and conditions.

$90 million works out to $500,000 per day, so this is a very, very good sign that dayrates are not falling as much as I feared they might. On the other hand, the extension was only for six months. But this news tempts me a little closer to buying more Seadrill.

Now, on to a bigger picture for the rest of the year. Russ Winter has a chart from Worldsteel showing that China is using 2.25X the steel of the USA, Europe, and Japan put together. This is not sustainable.
China is not sustainable. I think deflation will really pick up over the next year. This means two things: bonds, and short commodities and commodity equities. I already have the bonds at a 50% position. Short commodities is currently limited to 10% short copper via SCCO. I have two positions in FXI puts, but need to look for some more. Russ Winter recommends EDZ. Until I find something better, I'll look at trading in and out of this due to the volatility.

I need to look for where the margins will get compressed when Chinese demand finally drops. A quick check shows the large Brazilian miner Vale (RIO) at a P/E of 4.7, versus Arcelor Mittal (MT) at a P/E of 25. Another possibility is CAT, which is near a 52 week high with a P/E of 36.

I'm also going to look for an opportunity to lock in a long-term Jan 2012 oil put via USO or perhaps the more aggressive DIG. Oil has the added advantage of Iraqi production reaching a possible 5M bpd by the end of 2012.

Last Minute Update!

This time the short squeeze is on in my favor. GAP is up 26% today. A quick glance shows short interest at 14 million shares.
The five day chart shows volume of 8 mil, with spikes in volume corresponding to drops in share price. Monday, Tuesday, and Wednesday all show small increases in volume pushing up the price by a few cents. Total volume was about 6 million. Today, the effect on the stock was magnified greatly. Today alone, volume was 5 million shares. It looks like a lot of shorts have already covered. So I took everything off the table except a 2% toehold.

Sell 8% GAP @ $3.36, +24.0%.

Doubling Down on DJSP

First trade:

Buy 10% DJSP @ $3.90.

Doubling down on this. I finally read their earnings report, and it convinced me that it's dirt cheap. Earnings were "disappointing" at $0.45/share. Maybe there's some non-public info that's crushing the stock, but everything in the open looks good. I also think their technology implementation could reap major gains in productivity for them. Finally, I am impressed with management's toughness in sticking to their guns and refusing to provide earnings guidance. This despite the stock price getting hammered.

Buy 0.5% position in NG Jan '12 10 Calls.

Gold looks like it has successfully tested the 200 day moving average. Almost all the gold stock options are showing yearly lows in implied volatility and the lowest prices in months. If gold rebounds, they are really cheap. This position is small. It's very aggressive, but extends out almost 18 months. The potential upside is huge.

Trades!

Buy 1% position FXI Jan '12 30 puts @ $2.53.

China's chances of reflating its housing bubble are slim, in my opinion. According to some reports, construction is 50% of Chinese GDP. The Chinese government will just print to extend the bad debts, of course. But Michael Pettis says that the Chinese consumer is the one who really pays. If Chinese consumption drops (along with the developed world) commodity demand will plunge. The yuan has a good chance of dropping, which would put tons of pressure on FXI. This purchase also extends my portfolio maturity considerably.

I am also watching DIG and USO for shorting opportunities.

I've also decided to do some bargain hunting bottom fishing:

Buy 10% DJSP @ $4.75.

DJSP is a play on foreclosure activity in Florida. They've cornered the market and 80% of their revenue is tied to David Stern's law firm. It's basically his way of monetizing his share of the law firm by spinning off and publically listing the non-legal administration of foreclosure services to banks and lenders. I have no idea if banks and GSE's will finally start to step up foreclosure activity. However, the price is right. EBITDA is 95% of market cap. How cheap is that? Unbelievable. In addition, there's a huge short interest against the stock. Lawsuit liability? Maybe, but the company is a cash cow, and I expect the housing market to resume its price plunge by the end of the year.

Buy 10% GAP @ $2.71.

Great Atlantic and Pacific Tea Company fell over 30% last Friday as the company announced dismal earnings and its second CEO change in 6 months. Now it's either dirt cheap, or worthless. But people need groceries, and if any cash flow can be squeezed out of revenue, then this could be another recovery story. In addition, there's an enormous short interest on the shares. Another promising sign is that the price fell on 10X average volume. Most likely reason is that a huge institutional investor just threw in the towel. The price could take a nice bounce as shorts take their profits.

Damage Control

Looks like I need to do some damage control today.

Close LVS @ $25.05, -8.9%
Close EDZ @ $37.03, -9.1%

Just some housecleaning, as my bearish timing is off. I've decided to cut off losses after 5%. I know it's an arbitrary number, but risk tolerance is arbitrary. I'll start low, and expand it later if it doesn't work for me. Just an experiment.

Bernanke Sees Train Wreck Dead Ahead

Bloomberg reports that Bernanke Says Fed Prepared to Act as Needed to Aid U.S. Growth. Translation: Bernanke sees growth going to zero by the end of the year. I never read the Fed Chairman's statement as anything other than propaganda. In fact, I always apply a "what do they want us to think" filter to every word out of his mouth. Why? No exclusively because I'm cynical. It would be imprudent for Bernanke to say what he really believes. It might cause panic. His job is to remain professional. So, he's going to address the current situation in a believable manner. How else can you explain why he says that the Fed's thinking about winding down crisis measures at the same time that they "remain prepared" to enact additional mysterious measures? Obviously, he's talking to the bulls in the first case and the bears in the second.

Be that as it may, I am pretty certain that Bernanke's scared stiff. What tools does Bernanke have left? Nothing. He could buy long Treasuries, but that wouldn't do much. The long bond will keep falling anyway. If growth goes back to zero, there's not much that can be done on the monetary side.

Sovereign Defaults?

Rather than default and money printing to pay down debts, I see a spread of austerity. In Japan because their debt is domestically held. If yields rise, the govt. forces banks to hold debt, but has to cut back on spending. In the U.S., austerity will take the form of higher taxes, state spending cuts, and a shrinking trade deficit.

However, the trade surplus countries China, Japan, and Germany will be competing more fiercely than ever for the shrinking global export market. They will fight to devalue their currencies. China, especially, faces the threat of inflation if they continue bubble blowing.

Austerity = deflation.

Trades!

The charts look ripe for a resumption of the bear market. Volume on this quick rally is anemic. Correlation between stocks is the highest it's been since the '87 crash. Finally, option implied volatilities are actually lower for short-term than for longer-term expiration dates. Time to wade back in. And the drop in long bond yield is outrunning the Dow to the downside.

Buy 10% position in EDZ @ $40.74.

Buy 1% position in Aug SPY 102 puts @ $1.31.

This is a nice little bet on the SPY retesting this years' low.

Trade!

Taking the profits on this one off the table. Now that it's deep in the money, I don't feel it's worth the risk of losing my gains here.

Sell to close 1% (initial) position in SPY Jul10 108 put @ $6.13, +258%.