Monday, November 30, 2009

For How Long Will Cash Be Trash?/Money Market Yields as a Source of Funds for Global Risk Trade/Sold PST

1. Money Market Funds as A Funding Source for the Risk Trade: In a few recent posts, I discussed the carry trade as a funding source driving increased prices for risk assets on a global basis. End of the Carry Trade-Not Likely/Euro vs. U.S. Dollar U.S. Dollar and the Carry Trade Another source, also created by the zero interest rate policy of the Federal Reserve, is the flight from money market funds, many of which are yielding zero to .25% for the exceedingly generous ones with low expense ratios. Andrew Bary pointed out in his column in Barrons that money market funds have suffered 271 billion in withdrawals since the start of 2009.

Those funds are largely finding their way into risk assets, helping to facilitate a rise in prices, along with other funding sources, based on increased demand. Bary points out that bond funds, for example, have been receiving 8 billion dollars or more in recent weeks. I have made similar observations about investors searching for any kind of yield by jumping in mass into bond funds paying less than 4%. The sums are staggering year to date: see Item #4 /LONG TERM BEAR MARKETS/Bought Vanguard Bond Funds-Another Rule Violation In fact, I was one of them recently, investing a very small amount in two Vanguard bond funds. And, I am no fan of bond mutual funds at their current yields: For BND: Is it Safe is not the Right Question. Instead Ask What are the Risks & Rewards/Assume Lost of Principal Possible In that last linked post, which was written in June 2009, I discussed several of the risks associated with bond funds and why I was investing then in alternatives to bond funds. Since then, my intellectual defenses, still viewed as sound and persuasive, against buying a bond fund are starting to wear down a tad after more months of earnings nothing in money market funds, and looking at many more to come. So, I understand what is motivating other investors to transfer funds from a money market fund to a bond fund. Ultimately, the Fed will produce a number of speculative asset bubble prices by keeping rates near zero for another year. One such asset class will be bonds, particularly treasury bonds, for the reasons outlined above. And when that bubble is burst, a lot of individual investors will be burned.

Bary also points out the recent newsletter from Bill Gross (PIMCO) which I discussed in an earlier post, where Bill recommended electric utility stocks as a possible alternative to cash earning nothing. I already own several electric utility stocks, and will probably buy a few more. After reading that column from Gross, I did add 100 of XLU: Bought 100 XLU/Bought 100 QAI/SOLD AUY Bought 30 ZBPRC at 18.4/

In his letter, Gross was kind enough to do a calculation of how long it would take to double your money at .01%. The answer is around 6,932 years, and the Old Geezer said upon hearing that: "I don't think I will make it". The LB replied that the actual number would be longer after taxes. You might have to go back to the time when Adam and Eve walked with the dinosaurs (Creation Museum), and count forward, to double your money after taxes and inflation at .01%. LB noted that, with those caveats, money would never double even if you started with those amoeba swimming in some kind of hot tub.

2. LGF (owned Lottery Ticket category): Now that I own a tiny slice of a motion picture company, I find myself checking the weekend box office numbers for its current releases. Lions Gate has one film in the top ten, and it has started to lose steam. For the three day weekend ending November 27, the estimated revenues for the movie "Precious", a LGF release, were 7.1 million, down from the 11 million in the prior week , but enough to keep the film in the top ten at number 8. The total to date is estimated at 32.4 million. A Wikipedia article has a detailed discussion about this film. A few Oscar 2010 nominations may help to spur ticket sales some. I have started to see some commercials for the next LGF release called "Brothers" scheduled for release 12/4: LIONSGATE

3. Ian Shepherdson's Opinions Summarized in Morgenson's NYT Column-Cash is Trash and For How Much Longer? I read with some interest Gretchen Morgenson's column in Sunday's NYT that focused on the opinions of Ian Shepherdson, the chief economist for High Frequency Economics. While many have focused on the positive ISM releases on manufacturing activity, including me, Shepherdson pointed out the weakness in similar type surveys conducted by the National Federation of Independent Businesses which still indicates recession level activity. I have noted the same in a recent post, but my review of that data is more balanced than the pure negativity expressed in Ms. Morgenson's column: See Item # 4 Retail Sales/Chinese Currency/The Movie "Precious"-LGF/Medicare Fraud & the Government/ING The index developed by this association of independent businesses has started to rise from the depressed levels in March, and the last reading was close to the threshold level of 90 in that index. I am following this data series, and I am concerned about the results contained in the last survey.

I was more interested in Shepherdson's opinions about when the Federal Reserve will start to raise rates again, and the reasons given for his opinion. I am not a theoretical person but a practical one. I want to gain some meaningful feel for how long cash will be trash which will dictate in part the risks that I am willing to assume now. His prediction is for the first increase in the spring of 2011. His opinion is based on the precipitous fall in bank credit by 8% since October 2008, a trend that is accelerating. To prevent a collapse in the broad based money supply, the Fed has embarked on its asset purchase program, still continuing for mortgage backed securities, which creates deposits to offset the credit contraction. Until that credit contractions stops, Shepherdson does not see the Fed raising rates. Some of this credit contraction talk was echoed recently by Meredith Whitney. /Sarah and Meredith Before trying to measure the importance of a decline in credit availability, you need to assess how much of that contraction is just the withdrawal of excessive credit availability, created with abnormally high leverage undertaken by financial institutions. Relying on raw numbers, without context, can result in drawing erroneous conclusions.

I has had a different take away than Shepherdson on the N.F.I.B.'s survey about the availability of credit to small business. Shepherson believes this data shows that "credit continues to remain troublingly hard for small business to come by". This is what the November survey said about credit, and one can draw their own conclusions:

"For those who want to borrow, getting a loan continues to be difficult, with
a net 14 percent reporting loans harder to get than in their last attempt.
Thirty-three (33) percent reported regular borrowing, unchanged from
September. . . .

Twenty-nine percent reported all their borrowing needs met (down 1 point)
compared to 9 percent who reported problems obtaining desired financing
(down 1 point, not seasonally adjusted)."

It is clear though that small businesses have not seen the kind of recovery reflected in the ISM manufacturing surveys.

So, what does all of this mean? For now, I would say that it is currently highly probable that the Fed will remain on hold for six more months with its nil interest rate policy, and more probable than not on hold for another 6 to 9 months which is sufficient for me to continue to use cash, earning close to nil, to increase my exposure to income generating securities, generally defined today as meaning a security yielding more than 5% for a stock, 7% for a bond, and 8% for an equity preferred stock.

4. Sold 30 PST at $50.06 (see Disclaimer): Based on my view now that 10 year treasury rates will continue to remain abnormally low for at least a few more months, I took a loss on PST and will start to establish to establish my hedges for my long corporate bond portfolio next year when I have a better feel for how long the Fed will keep the federal funds rate at 0 to .25%. I intend to use both PST and TBT as hedges for my overweight corporate bond portfolio. /Hedging Bond Positions/ This brings me, for now, back to no position in either PST or TBT. I am going to use those funds to increase a hedge for a different asset.

The PST shares were sold at a small loss with the position just established 0n 11/10 at $52.45. Item # 4 Added 50 of the TC DKK/Bought 70 PYT at $15.75/Sold All Shares TIP ETF/Started Hedge for Corporate Bonds/Added 50 of ABWPRA

5. India GDP: India is doing its part to bring the world out of the Near Depression. India's GDP grew 7.9% in the 3rd quarter compared to the same quarter a year ago.

6. Chicago PMI: This index rose to 56.1 in November, the highest reading since August 2008.

7. Dubai: Just another black hole for lenders. I read with interest this morning a statement by a fellow, Abdulrahman al-Saleh, director general of Dubai's Finance Department. He said that sure Dubai owns Dubai World, but the government does not guarantee the debts of its controlled entity. Wow-not responsible for its own debts! Do they have any idea how that sounds to a Western ear? So, why would anyone lend anything to Dubai World? It would be negligent for a Western financial institution to extend them any credit at all. Do they think there is any legal protection in a Dubai court after the government owned Dubai World defaults?

Sunday, November 29, 2009

Gold (GLD) and Dangerous Parabolas/Dubai/Kazakh Bank

1. Gold and Dangerous Parabolas: A dangerous parabola is an upward spike in price usually occurring at the end of a substantial bull move in price. An example would be the move in the Nasdaq average in 1999 which occurred after a substantial run up in that average since 1993. A similar dangerous parabola occurred last year in the oil market as prices spiked to about $140 a barrel, and in Japanese stocks in the late 1980s. Some of my prior discussions about categorizing parabolas are in these posts:

A non-dangerous parabola would be an upward spike in price occurring at the end of a nasty bear market. This kind of parabola may need corrections to resolve itself, but nothing like the typical 50% plunge that can occur at the end of a dangerous parabolic move. An example of a non-dangerous parabolic move would be the rise in the S & P 500 averages in the months after August 1982, or October 1974, or March 2009, all of those parabolas occurred at the end of long term secular bear markets (i.e. August 1982) or after an extremely strong cyclical bear move, as in our recent climb off the March lows or in the rally from 1974 to 1976 after the huge bear decline in 1973-1974.

Gold had a dangerous parabolic move in its last bull market, during a five month period between August 1979 when gold moved from around $300 to its peak at $850 in January 1980. Gold Price History The following site has a long term chart of spot gold prices from 1975 to 2008 which shows the parabolic move from that earlier bull market. Gold The Wikipedia article about gold as an investment has a chart starting in 1968, which clearly shows the bull market in gold starting in 1972 at around $50 per ounce. So by August 1979, gold had already enjoyed a bull market rising from $50 to $300 over about a seven year period. The last move from $300 to $850, coming after a long term bull move, is what I call a dangerous parabola. The reaction move took gold back to $330 an ounce by March 1982.

Over the weekend, I read an article written by Daryl Guppy who believes that gold is in a dangerous parabolic move now. He opines that a break in the parabolic trend could cause gold to retreat quickly to a $1000 an ounce. If he is correct about that downside target, then a 10 to 15% correction in price is not how a dangerous parabola corrects itself. A fifty per cent decline is more like a normal reaction at the end of a dangerous parabola, as shown in prior reversals in asset prices which underwent a dangerous parabola ranging from commodities to stocks.

I would start the current cyclical bull market in gold as starting in or around December 2001 when gold was selling for $275 an ounce.

I own both gold and silver bullion. My last purchases was when gold was trading in a narrow band between $250 and $300.

Normally, my response to what I would characterize as a probable dangerous parabolic move is to sell the asset undergoing the parabola, or at least make a substantial pare. I am not able to do that with my gold and silver. In fact, I have never sold any of it.

I mentioned previously that my first gold purchase was when I was 13, a five dollar (1/4 ounce) Liberty Head gold piece minted by the U.S. in the 1880s, purchased for the then staggering sum, at least to a 13 year old, of $30. I was also using my earnings to buy at face value dimes, quarters, and half dollars that contained 90% silver which was the case for those coins minted in 1964 or earlier. Those earnings were all available for investment back then, in the sense that I had no living expenses at 13, but there is only so far that one can going earning a $1.25 an hour. When I started to add to my gold, I also added to my silver by buying one of the more beautifully designed coins ever minted by the U.S. Mint, the Walking Liberty originally issued as a half dollar with 90% silver content, from 1916 to 1947 ( Walking Liberty Half Dollar - Wikipedia), but was reissued by the Mint as a silver dollar which could be bought at a slight premium to their bullion value starting in 1986. The American Eagles Program of the United States Mint I bought several rolls of those. And those coins are one troy ounce of 99.9% grade silver.

So, since I am unable to sell gold or silver, locked in a bank lock box, and rarely seeing the light of day, I recently embarked on a hedging program. The purpose of the hedge is to make me feel better in the event prices to plunge. Bought 50 GLL Gold- U.S. Treasury Note and Bond Prices-U.S. Dollar I do not believe that the hedge has any real monetary value.

The purpose of some recent posts is show that the correlation between gold and inflation, or gold and the value of the dollar is not as strong as many people believe. Item # 4 : Bought 100 Activision/End of the Carry Trade-Not Likely/Sysco/Euro vs. U.S. Dollar Item # 3 U.S. Dollar and the Carry Trade/Sold 100 PMK at 9.2/Gold & Inflation

When the dangerous parabola starts, one thing is for certain, it will end and the end will be nasty. While that is a truism, a cliche, it does not help me now in determining the length and duration of the current parabolic move in gold. I was saying in early 1999, at the beginning of the dangerous parabolic moves in stock averages particularly in the Nasdaq average, that the move was a dangerous parabola, and yet it continued for another year or so before imploding. I did not participate in that one on either the upside or the downside, just missed it altogether.

I would not be surprised if gold either continued its spike upward toward $1400 or started its correction soon. No one knows about the timing.

So, for now, I am content to add to my hedge in stages as previously discussed, and I am now willing to ride GLL down to around $6 before taking a loss on the position (see disclaimer). I do not view that position as a bet or a gamble but simply a hedge. I have discussed the tracking problems with the double short ETFs, which requires me to monitor that issue daily. Another reasons for selling the position would be a tracking error developing over time that I view as both substantial and adverse, meaning it is going the wrong way on the tracking.

2. Dubai: Apparently this Emirate, part of the United Emirate Federation, is adept at borrowing and spending large sums of money, which sounds familiar, and has been running large budget deficits for a long time. It imposes no income or sales taxes, which sounds good, and it has insignificant oil revenues which is mostly controlled by Abu Dhabi. Dubai - Wikipedia NYT Based on what I have read over the past few days, Dubai's revenue stream appears to be borrowing ever increasing amounts of money to spend on vast construction projects, that lenders were apparently willing to extend based on some sort of implied assurance that the UAE and Abu Dhabi would stand behind the repayment of those debts. Earlier in the year, Dubai floated 20 billion in bonds, and sold 5 billion in bonds just recently to two majority owned banks by Abu Dhabi. Now, what exactly happened to that 25 billion? It does not appear to me that the recent credit facility announced by the UAE central bank addresses the core of the problem, the assumption of 60+ billion in debts with little in the way of revenue to service and to repay that debt. dubai1129.pdf It appears to be nothing more than a temporary band aid. Reuters

You have to wonder about the willingness of banks to pour money into a dark hole, with little in the way of legal recourse. Another example of that mindless lemming behavior is contained in a NYT story about the Kazakh Bank in Kazakhstan. Good luck in getting those billions back!

Saturday, November 28, 2009

Bought 100 Activision/End of the Carry Trade-Not Likely/Sysco/Euro vs. U.S. Dollar

1. End to the Carry Trade?: Last Friday, I discussed how the U.S. Dollar has become the currency of choice to effectuate the carry trade, whereby funds are borrowed in dollars at abnormally low interest rates, and risk assets are then purchased with those borrowed funds. U.S. Dollar and the Carry Trade/Sold 100 PMK at 9.2/Gold & Inflation Those assets would include stocks, junk bonds, gold or other commodities, or even another currency like the Australian dollar where rates are higher than in the U.S. For assets purchased that are not priced in dollars, the speculator would sell the dollars borrowed to buy another currency.

I read Randall Forsyth's column in where he argues that the Dubai debt problem is some kind of harbinger of the end to the carry trade. I am convinced that the abnormally low rates in the U.S. will work its way into more demand and higher prices for risk assets. The excess liquidity provided by the central banks is not finding a home in the real economy. | U.S. Department of the Treasury Bank Lending Down I would agree that the evidence points to it flowing into the purchase of assets. The carry trade is just one mechanism which facilitates the flow of funds to what Forsyth calls the global risk trade.

It would be premature to call the end to the carry trade based on Dubai debt's woes. The evidence cited by Forsyth for the end game, including Fridays small rise in the U.S. dollar, the one day fall in the market, and a small uptick in the prices of treasury securities, are far from convincing. If I looked at the market action from late last week without knowing anything about the Dubai World news, I would not draw any conclusions from it, other than there was a minor correction in stocks on light volume.

Does the Dubai World news mean anything long term? The excess liquidity has not been drained from the market; there is still little demand for those funds in the real economy; the alternative safe investments are still yielding close to nil; and Dubai has not collapsed. Some of the oil rich Arab states with more at stake may intervene. And, the size of the Dubai problem is relatively small even compared to the bailouts of single firms such as AIG and Citigroup.

If there is to be some unwinding of the carry trade, I would suspect that the origins will have nothing to do with Dubai World, but the simple fact that the riskier assets have appreciated so much in value that now would be an opportune time to unwind that trade by taking the gigantic gains before the herd starts moving the other way. And, while it is hard to imagine now, eventually U.S. interest rates will rise, possibly sooner than the consensus estimate of late next year, thereby making a continuation of using the dollar as a source currency unappealing.

One movement, the strength of the Euro against the dollar, makes no sense to me for the reasons previously discussed in a prior post. I read over the weekend that the experts had models that showed the fair value of the Euro at around 1.31. And, the buyers of that currency acknowledge that it has few friends at the current price and there is no large Euro area current account surplus to support the Euro. Further the buyers believe the European Central Bank will keep its benchmark rate abnormally low at 1% until the end of 2010. But, notwithstanding all of that the same analysts predict a rise in the Euro to the mid $1.50s or as high as $1.60 against the dollar. Apparently, the analysts are recommending more buying of the Euro based on the belief or hunch, or whatever you want to call it, that it will become even more over valued, sort of the buy and sell to the greater fool theory of investing. I currently own 50 shares of the double short ETF for the Euro and have long positions in the Canadian dollar and the Norwegian Krone. (see disclaimer)

I can see why some in Europe would want to use their currency to buy assets in the U.S. priced in dollars at the current exchange rates. I wish that I could buy some European securities using a U.S. dollar to buy €1.5 in Euros. (I just figured out how to type the Euro symbol on my Mac keyboard: shift+Option+ 2). Even Old Geezers can learn stuff, though more slowly and better than the Young Turks.

2. Bought 100 Activision Blizzard at $11.6 Friday (ATVI)(see disclaimer): This is the RB's contribution to the portfolio. Fortunately, the LB woke up long enough late Friday to keep the RB from entering an order to buy 1000. I am not going to allow the RB to explain its rationale, mostly gibberish about a video game Call of Duty. For those who are gamers this stock needs no introduction. It is the result of a 2008 merger between Activision and Vivendi Games. As a result of the merger Vivendi owns about 52% of ATVI.

ATVI has no debt. The recently filed 10-Q shows cash and cash equivalents of 2.360 billion and another 361 million in short term investments or about $2.15 per share. The current consensus estimate for 2010 E.P.S. is 77 cents.ATVI

Some of the major franchise titles include Call of Duty, Guitar Hero, Tony Hawk and World of Warcraft (the largest online role playing game with more than 11 million subscribers). Other titles include X-Men, Jame Bond, StarCraft, Diablo, Spider-Man & Transformers. (see pages 37-38 of Annual Report:

Activision reported recently that its new edition of Call of Duty reached 550 million in sales during the first five days after its launch: Reuters This is a link to a recent downbeat WSJ article about the videogame industry in the current economy. Still these games provide a lot of entertainment value for the dollar. It took the OG about a month to make it all the way to the end of Call of Duty 2 on the Xbox, after a few thousand violent deaths along the way.

3. Sysco (owned): Barrons has a favorable article on SYY in this week's issue. The author emphasizes the dividend yield, and the possibility that the shares may return to a historic average 20 P/E which would translate into a $40 price. SYY closed Friday at $26.83. SYY: The current dividend yield at that price is about 3.7%. In my last discussion, I emphasized Sysco's history of increasing the dividend, which is an important consideration for me. Item # 4 Sysco Some prior posts on this stock include the following: Sysco & Dupont Mentioned in Barron's Online Buys of CPB LQD SYY XKK

4. Observations on Gold and DXY Year over Year: Some say, with good reason, that gold goes up when the dollar goes down, but it far from a one to one correlation or a constant. Between 9/15/2008 to 3/6/2009, I ran a comparison of DXY, the Dollar Index, and GLD, the ETF for gold bullion. During that period, the dollar gained against the basket of currencies contained in DXY by about 15% and GLD gained about 20%. Between January to early March, both the dollar and gold were rising in price. Since March, however, the price divergence is just huge, no other way to describe it .DXY Index Charts - US Dollar Index Future But the year over year gain in the GLD, approaching 55%, is what causes the divergence, since the DXY has declined just about 6-7%. (a decline in DXY indicates dollar weakness against the basket of foreign currencies which include the Euro, Yen, British Pound, Canadian dollar, Swiss Franc, & Swedish Krona with the Euro having over a 50% weight: U.S. Dollar Index - Wikipedia)

Gold and inflation were discussed in Item # 3 from yesterday's post: U.S. Dollar and the Carry Trade/Sold 100 PMK at 9.2/Gold & Inflation

Friday, November 27, 2009

U.S. Dollar and the Carry Trade/Sold 100 PMK at 9.2/Gold & Inflation

1. Weakness in the Dollar Tied In Part to its Use in the Carry Trade: With the Federal Reserve keeping the federal funds rate near zero, the U.S. dollar has replaced the Yen as the currency of choice to implement the carry trade. The extremely low U.S. dollar Libor rate is also an important factor in this trade. This kind of trading activity weakens the U.S. currency, as investors borrow short term funds in the U.S., then sell the dollar to buy riskier assets priced in foreign currencies. This process is explained in this article from the Financial Times (subscription needed for FT). But, if the dollar starts to rally in a flight to safety, some speculators may decide to unwind that trade by buying back the dollar, thereby adding to its rise. This would be particularly true for those who sold the dollar to buy assets priced in foreign currencies, such as emerging market stocks that are taking a big hit today. It might also prove to be true even when the asset purchased with borrowed dollars, e.g. gold, is priced in dollars if that asset starts to undergo a correction in price. That asset might be sold in order to unwind the carry trade. I did notice that gold was falling some this morning using GLD as a proxy: GLD

Being a relatively simple minded individual investor who has never participated in such complex trading strategies, it seems to me that the use of the dollar as an instrument of the carry trade is potentially more dangerous than using the Yen or the Swiss Franc. There is a lot more natural demand for the U.S. dollar than for the Swiss Franc or Japanese Yen, making the U.S. currency a potentially less desirable candidate for the carry trade since those other factors could cause a non-temporary spike in the dollar's value. The natural demand for the dollar, arising in part from its status as a reserve currency, could overwhelm the dollar selling by speculators to fund their carry trades. The loans taken out to finance the carry trade are short term, and ultimately have to be paid back in dollars. To the extent the dollar starts to rise again based on factors unrelated to the carry trade, it would consequently become more costly to unwind the trade by selling the asset bought with borrowed U.S. dollars (which may be declining rapidly in value due to events causing a spike in the dollar which hurts), then buy back the U.S. dollar (rising in value which hurts), and then pay back the loan priced in U.S. dollars.

The dollar is gainly broadly against major currencies other than the Yen today. It is particularly strong against the Australian dollar. It is my understanding that some traders may borrow funds in U.S. dollars and buy Australian dollars. Then when that trade is unwound, the Australian dollars have to be sold, causing that currency to fall in value.

2. Sold 100 PMK at $9.2 on Wednesday (see Disclaimer): I am going to keep the 50 shares bought in the regular IRA recently at $8.21. Added 50 PMK at $8.21 The shares sold last Wednesday were bought at $8.35 in a taxable account. Bought 100 PMK/ I did not expect a price rise above $8.75 when I purchased the shares, so I decided to sell my higher cost shares for a small profit. This is a junk rated bond.

3. Gold and Inflation: I made a comment recently that gold could hardly be viewed as a hedge against inflation for a purchaser in 1980 near the peak price (until recently) of around $850 an ounce. This website contains a monthly price table for gold: Gold Price History The $850 price was next realized some 27 years later in late 2007. That is what I would call a secular bear market of a far longer duration than a secular bear market for stocks. Needless to say, for a buyer in 1980, gold did not provide a hedge against subsequent inflation. I found yesterday a calculation that gold would have to rise to almost $2200 to match that 1980 price now adjusted for inflation. Inflation hedge? And, 27 years is an awfully long time to wait for a profit.

An investor who bought gold in 1974 at say $150 an ounce, held for that first bull cycle and through the entire 27 year bear market, and sold today would have fared better against inflation with almost a 800% gain. When viewed from the perspective of that longer term cycle, one could argue with a straight face that gold did hold its value adjusted for inflation. I would add however that very few humans could hold an asset for 27 years waiting for a bull market to emerge. But over that 35 year time span, from 1974 to now, gold has done okay. It has failed as an investment for the purchaser in 1980 even after the recent price rise.

4. Tidbits: I have no interest in ING's rights issue, except that I hope for its success. I am not concerned about common share dilution as an owner of the hybrids IND, INZ and IGK. And, it is clear that a successful rights offering is important for the hybrid owner in order to get the EC off ING's back. The EC has made it clear that it will not compel a deferral of the hybrid distributions upon a successful rights offering.EC Approves ING's Restructuring/ EUROPA - Press Releases - State aid: Commission decisions on KBC, ING and Lloyds – frequently asked questions The common shares of ING are taking a hit this morning, falling below $10 in early trading, based on the 52% discount of the rights offering to the prior closing price ( FOX). I suspect that the Dubai World situation did not help the pricing. The issue price would be 4.24 Euros per share, six shares for every seven held: Reuters

There is not much of a response to the Dubai World news in the prices of treasury notes and bonds. Using the ETFs as surrogates, I noticed that TLT was up just a tad this morning, a negligible 18 cents: TLT ISHARES BARCLAYS 20 Year Treasury The 7 to 10 year treasury ETF was doing slightly better, though up only 29 cents in early trading: IEF: 7-10 year Treasury This minor response indicates that the big money crowd is not overly concerned about Dubai, at least for now, maybe that will change by next Monday when more of them return to work. Most of the European stock markets did recover today.

Thursday, November 26, 2009

Gold- U.S. Treasury Note and Bond Prices-U.S. Dollar

1. Treasury Yields-Gold-U.S. Dollar: Prices for U.S. treasury notes and bonds rose Wednesday as investors were eager to buy seven year treasury notes at auction with yields of 2.835% with the OID. pdf The U.S. dollar continued to slide with the Euro surging to over a $1.51, while gold continued its inverse relationship to the dollar rising $21.20 to $1,188.6 an ounce for the February gold contract on the Nymex. The WSJ had an article saying that gold rose on inflation fears. Well, if that was true, why did treasury notes and bonds rise in price and fall in yield. The 10 year treasury note rose 11/32 to yield 3.279%, and the 30 year T bond increased in price by a similar amount to yield 4.238%.

A lot of explanation can be given for this action. One esoteric rationale is that gold is no longer an inflation hedge, at least in the current cycle, but a quasi reserve currency that has at least temporarily replaced the dollar as a repository of safety. From my perspective, which is apparently shared by many others, the Federal Reserve has embarked on a campaign to debase the value of the currency with its monetary policy and quantitative easing.

A simpler explanation is that the Federal Reserve and other central banks have signaled their intent to keep interest rates at abnormally low levels for an extended period, which causes many investors to take more risks, and that would include borrowing money in dollars and yen and buying more risky assets like gold. There were reports on Thanksgiving, for example, that some large investors were selling the dollar and buying gold.

Another issue is that gold looks expensive to a U.S. citizen but it not as expensive to a European desiring to make a purchase in Euros. While a U.S. citizen could have purchased an ounce of gold bullion for $1192 last Wednesday, the same ounce of gold would have cost only 788 Euros.

Sometimes, prices go up because prices have been going up, which draws more people into the trade, thereby creating more demand, and that in turn causes prices to rise, and so on until it bursts. I suspect that this kind of herd behavior is the main impetus now in the rise of gold and the fall in the dollar. The stories that people tell themselves and others about the reasons for a price rise play an important role in continuing and accelerating the rise.

Lastly, in the current bull market for gold, it is not being bought primarily as a hedge for inflation, but as a hedge for some type of financial Armageddon event. The news about Dubai World, thought to have over 60 billion in debt, asking for a moratorium on debt payments to May of next year stokes this kind of fear which may still be simmering just on the surface of the psyche even now.

Since I am psychologically unable to sell my gold (or silver), sitting in a bank lock box, I am going to continue with my hedge program for the physical bullion as previously scheduled, and I will continue inching into my Euro hedge too. I bought my first gold coin when I was 13 with money received from mowing lawns at $2 per lawn. It cost me $35 for a 19th century five dollar gold piece. Back then, you could not buy gold bullion. I continued buying as an adult until the price exceeded $300 per ounce and then I just stopped. I do not believe that any of the purchases as an adult was as an inflation hedge. The purchases and the current hoarding are more of a hedge against most other assets collapsing in value. It is unusual for gold to have one of its best bull runs during a period of disinflation. The prior bull run occurred during the hyper inflationary period of the late 1970s and early 1980s. While some may fear inflation returning to hyper rates now, and that causes them to buy, the bond market is signaling that there is no serious inflation problem on the horizon. It is therefore hard to visualize inflation concerns being the impetus in the current bull market for gold.

During the prior heightened concerns of financial collapse, between September 2008 to March 2009, the dollar gained in value, as shown in the DXY chart. DXY Index Charts - US Dollar Index Future (a rise in DXY indicates the dollar is gaining strength against a basket of foreign currencies) It will be interested to see how the dollar reacts on Friday to the Dubai news. It is my understanding that a lot of European banks have some exposure to Dubai World.

One correlation, though, makes no sense to me. I am having some trouble understanding why gold is rising without inflation, treasury prices are rising along the entire yield spectrum to produce yields near historic lows, and the dollar is falling into some kind of abyss. The last part of that trade, the fall in the dollar, makes no sense to me with bond prices and gold prices rising.

Wednesday, November 25, 2009

Bought 50 of the TP STLPRA/ Fed Minutes/Negative Home Equity/FDIC Deep in the RED/WIN SNV

1. Negative Home Equity: First American CoreLogic reported yesterday that 1 in 4 homeowners owe more than their home is worth. This does not include all homes in the U.S. but 47 million homes with mortgages or over 85% of the homes with mortgages. This report is available at the firm's web site. The WSF had a helpful graph which shows the negative equity percentages by state. In states that displayed the most madness, the negative equity percentages are staggering. Florida for instance has a 44.7% negative equity percentage, Nevada is at 65%, and Arizona is at 47.9%.

The government has its home price data that it collects based on Fannie and Freddie mortgages. This data showed a .02% seasonally adjusted increase in home prices with that subset in the third quarter. .pdf

2. FDIC Insurance Fund in the Red: The FDIC reported yesterday that its insurance fund fell into the red by 8.2 billion. NYT Also, the number of banks on the FDIC problem list rose to the highest level in 16 years increasing to 552 as of 9/30, compared to 416 as of 6/30. FDIC: Press Releases - PR-212-2009 11/24/2009

3. Five Year Treasury Auction: The five year treasury was auctioned yesterday to yield 2.175%. The total auction proceeds were over 43 billion. .pdf The average rate on a 30 year mortgage is below 5%:

The RB just had an idea. Once the U.S. has borrowed all of the money in the world, drained all of those suckers dry of their cash, the U.S. could then lend some of the money back at higher rates and make money on the spread.

4. Bought 50 of the TP STLPRA at $8.99 Yesterday (see Disclaimer): I placed this TP in my regular IRA, so that I can receive some value in the event it tanks on me, by including it in the next Roth conversion. This a $10 par value typical Trust Preferred issue, a maturity date in 2032, and a coupon of 8.375%:

I have mentioned that a Trust Preferred security is frequently confused with a regular preferred stock. A typical bank trust preferred security represents an undivided interest in a junior bond held in a Delaware Trust form by the bank. In the case of STLPRA, the bank is Sterling Bancorp (STL) and the name of the trust is called Sterling Bancorp Trust I. That trust then sells "preferred" shares in the trust to the public, hence the name trust preferred. STL owns the common shares of the trust. The proceeds are used to buy a junior bond issue from the bank. Sterling Bancorp then guarantees the performance of the trust in the manner described in the prospectus. The underlying security in the trust is a bond, and that bond would be more senior in priority to the bank's common or traditional preferred stock which I frequently call "equity" preferred. The owner of STLPRA would not receive distributions classified as dividends but as interest.

Sterling Bank did participate in the TARP program, and the government bought cumulative equity preferred shares issued by Sterling. 8-K In order to defer the interest payments on STLPRA, Sterling would have to defer paying the government its dividends on its equity preferred.

Prior to yesterday, I was not familiar with Sterling which explains the very timid purchase of its TP. I did review a few materials. It is a small bank based in NYC. Sterling National Bank - Sterling Bancorp It does pay a common dividend which is important to an owner of the TP under the stopper provision. The bank is profitable, though earnings have declined during the recession. STL earned, for example, 10 cents in the last quarter, down from 21 cents in the year ago quarter. Gabelli funds have a significant stake in the common shares according to a recently filed 13-D. stl_05.htm The consensus earnings estimate for this year is 32 cents and 54 cents next year according to Y F .

This is a very thinly traded issue. When I placed a market order late in the day, there were no prior trades, and 100 shares was on the ask side at $9 and a few hundred bid at 8.85. Since I was satisfied with a $9 handle, I place an odd lot market order which was filled at 8.99. At a $9 total cost, the yield would be about 9.3%. I would expect little, if any, price appreciation over the near or intermediate terms.

As usual with these bank TP purchases, I would emphasize my belief that an owner of a junior bond in a bank seized by the FDIC would be holding a worthless piece of paper. Some investors are under the mistaken impression that they will receive something even for their common stock in a failed bank, which is why I would just say again- do not expect anything unless you hold a properly perfected security interest in collateral owned by that bank.

5. Fed Minutes: My investment strategy now is being dictated by the Federal Reserve. Savers and other responsible people in the U.S., who have not borrowed more than they can afford to service, will pay for the profligacy, greed and irresponsibility of others, many of whom, including the Masters of Disaster, have kept their spoils as the system rewarded irresponsibility and recklessness while socializing the risk. The FED continues to indicate that the savers will be put in the penalty box for an "extended" period. In order to receive some kind of return on my money, I have no choice but to take more risk. The alternative is to earn a negative real rate of return in treasury bills and money market funds. The most recent statement by the FED expressing its intent to penalize the responsible people in our society for an extended period is contained in its minutes from the early November meeting:

Part of the statement expressing the FED's current view about the future course of policy is as follows:

" The recovery appeared to be continuing and was expected to gradually strengthen over time. Still, most members projected that over the next couple of years, the unemployment rate would remain quite elevated and the level of inflation would remain below rates consistent over the longer run with the Federal Reserve’s objectives. Based on this outlook, members decided to maintain the federal funds target range at 0 to 1/4 percent and to continue to state their expectation that economic conditions were likely to warrant exceptionally low rates for an extended period."

A recognition of a possible, if not probable result of its policy was also made:

"Members noted the possibility that some negative side effects might result from the maintenance of very low

short-term interest rates for an extended period, including the possibility that such a policy stance could lead to excessive risk-taking in financial markets or an unanchoring of inflation expectations. While members currently saw the likelihood of such effects as relatively low, they would remain alert to these risks. All agreed that the path of short-term rates going forward would be dependent on the evolution of the economic outlook."

The Fed expects unemployment to remain well over 9% throughout 2010, with their current prediction being 9.3 to 9.7%.

5. Winstream (WIN)(owned): Windstream continues its acquisitive bent by agreeing to acquire Iowa Telecommunications for 530 million plus the assumption of 598 million in debt. The deal calls for Winstream to pay about 261 million in cash and the rest in stock. This would value Iowa Telecommunications at around $16 per share based on Winstream's closing price last Friday. I view this deal negatively on the price paid. Iowa Tel is expected to earn about 51 cents in 2009 and is highly leveraged. These acquisitions are starting to worry me some. This one makes no sense to me. Still, I do not need more money earning nothing, and my yield is good on the Winstream stock.

6. Synovus (owned Lottery Ticket category): Yesterday the common stock of Synovus closed at $1.49 with a volume of 43,298,222 shares.

The Chairman & CEO of Synovus Financial is a fellow by the name of Richard E. Anthony. Mr. Anthony has been CEO of Synovus since July 2005 and President since October 2003. Before then he was Vice Chairman since September 1995. He is currently being paid close to a million a year. BusinessWeek Why is he still employed? The closing price yesterday was the lowest price since the Yahoo Finance chart started in 1990.

I am curious why American companies insist on generous rewards for failure. Isn't it clear that Mr. Anthony has failed, along with his management team and the Board of Directors? A few months ago, there was a story in the Atlanta Business Journal about a 220 million dollar non-performing loan made to Sea Island Company, a resort developer, by Synovus. Atlanta (report of a lawsuit relating to disclosures about this loan )(see also yesterday's Bloomberg story) Mr. Anthony was quoted then as saying that the exposure to Sea Island was much higher than appropriate for a bank the size of Synovus. Really! And, when exactly did that occur to Mr. Anthony, before or after the 220 million dollar write-off? It is scary when you start to look closely at the competence of those running our financial institutions.

(The excellent series called the Reckoning in the NYT showed without a doubt that a large number of those Masters of Disaster were in fact far worse than worthless. The Reckoning - Series - The New York Times Actually, the Old Geezer is being too kind to them. LB says that as a group they had a negative value of about 5 trillion dollars. If the Masters of Disaster were experts in anything, it was in the creation of illusory profits as a base for their outlandish compensation. And who wants to defend now the hundreds of millions paid to the financial wizards at AIG's London Financial Products Unit NYT, or the twenty million a year "professionals" who used 40 to 1 leverage to buy CDOs squared containing subprime mortgages?)

The market is basically saying that there is no confidence left in Synovus, and more protestations of capital adequacy will fall on a lot of deft ears. If that is a correct assessment, it is not irrational. The bank has reported a comprehensive loss of 1.182 billion during the first nine months of 2009. (page 10 e10vq) The treasury sunk $967,870,000 into Synovus for equity preferred stock, more than the current market cap of the bank which stands at around 750 million at the $1.5 price. The recent pronouncement by Mr. Anthony concerning the bank's solvency (Reuters) did result in a temporary pop of a few pennies above a $2 handle on the stock, before falling to a new all time low yesterday of a $1.5. I am a recent shareholder with just a 50 share buy as a Lottery Ticket, viewed as speculative with a high potential of a loss. Even though I lack confidence in the management of this bank, to say the least, it is conceivable that the author of this article is right about the loss cycle peaking ( Guru), though I do not share his optimism.

7. Dividends and Interest: The Aegon and ING hybrids that I own will go ex dividend on Friday. This includes IND, IGK, INZ, AEB, AEH, and AEF. The two Zions equity preferred stocks, ZBPRA & ZBPRC, both owned, go ex dividend too along with my shares in the floating rate equity preferred issue from SunTrust Bank, STIPRA. Suntrust is paying just a quarterly dividend of just 1 cent a share to its common shareholders, but that 1 cent is as meaningful as a dollar under the stopper provision. Coca Cola common, owned, goes ex dividend on Friday. KeyCorp goes ex with its one cent per share common dividend, and I recently added one of its TPs and I own the common as a LT. PFK, the Prudential CPI floater, goes ex with its monthly interest payment. Prudential has another exchange traded bond, PHR, which goes ex with its quarterly interest payment. That one has a 9% coupon and is a junior bond maturing in 2068. Prospectus Supplement I do not currently own PHR due to the maturity date but I may get desperate enough to buy it soon. PennWest declared its regular monthly distribution of 15 cents Canadian. I take my dividend from Canadian companies in Canadian dollars.

Brookfied Infrastructure, a recent add (Added to BIP), is ex dividend today.

A cornerstone of my investment strategy is to buy a lot of securities that throw off cash, and to use that constant flow of income to buy more securities that throw off cash, hopefully making the most opportune picks with each reinvestment of cash flow, choosing among all types of income generating securities including preferred stocks (fixed and floating), synthetic floaters, trust certificates, trust preferred, exchange traded baby bonds, closed end investment funds with monthly or quarterly distributions, canadian energy trusts, and high yielding domestic and foreign common stocks. So this approach requires a lot of information about a wide variety of potential investments and a considerable number of judgments made continuously.

8. Tidbits: Frequently, those who played a role in the causing the Near Depression disclaim any responsibility for their role. In fact, they present themselves as a victim of some kind of natural disaster, rather than a cause of a man made disaster. It would be analogous to listening to a lawyer for an arsonist blowing smoke at the jury, arguing that his client was not responsible for burning that building down since he only started the fire in one room.

One major cause of the Near Depression is the assignment of a AAA rating to pools of mortgages securities known as CDOs by the rating agencies. Without that rating, the securities could not be sold by Wall Street, who would then use the proceeds to fund the origination of more mortgages by firms who are now bankrupt to borrowers who clearly could not afford the payments. In fact, those mortgage pools were frequently nothing more or less than toxic junk. This provided the fuel for the easy credit that caused a distortion in home prices to levels than made no economic sense based on incomes.

The rating agencies are now being sued for their role and are claiming protection under the First Amendment. Bloomberg They were paid by the Wall Street firms that bundled the securities for sale and who had to have that AAA rating to complete the transaction. So I read with amusement the following statement by Moody's in response to a suit filed by Ohio: “It is unfortunate that the state attorney general, rather than engaging in an objective review and constructive dialogue regarding credit ratings, instead appears to be seeking new scapegoats for investment losses incurred during an unprecedented global market disruption.” NYT

Some of my prior discussions about the role playing by the rating agencies in causing the Near Depression can be found in these posts:


Notable News 10 23 2008: We Drank the Kool Aid

Item # 8: Investment Grade Corporate Bond Spreads/ CPI FLOATER: OSM

David Faber's Program "House of Cards" discussed at Rendition to Somalia

Zuckerman editorial

A summary of some of the issues can be found in this article The Reckoning series from the NYT.

One thing will probably end up being true. Those who made money on each step in the transaction will keep their booty, whereas the ones who received nothing will pick up the tab for cleaning up their mess. All of that comes under the heading, life can be unfair, deal with it.

The ING shareholders are voting today on proposed breakup plan and the 7.5 billion Euro rights issue, the last step needed before ING actually starts to implement the restructuring plan recently approved by the EC. Reuters says the shareholders are expected to approve the plan.

Order for durable goods fell unexpectedly in October, declining .6%. Machinery had the largest decrease with a 8% decline. .pdf

Weekly jobless claims fell by 35,000 to below 500,000ETA Press Release: Unemployment Insurance Weekly Claims Report This data is seasonally adjusted. If you look at the unadjusted data , the total increased 68,080 to 543,926. LB had to think about that one for a second.

Added 12 p.m. ING shareholders approved the rights issue and the restructuring plan. Reuters Pending a successful rights issue, and I anticipate no problems now, the EC will not compel a deferral of the hybrid coupons.