Thursday, November 11, 2010

Ireland Going the Greek Way; Will We Follow?

“It was the banks doing crazy loans, it was borrowers taking crazy loans and a failure by government and regulators to do their jobs properly,” said Sean Kay . . .. “There was no adult supervision.”

Sounds like the U. S.

Instead it's Ireland, in a Bloomberg article about Ireland on the Brink.

Right now the U. S. is in a "Japanese" phase of my concept of a duality I have dubbed going or being Japanecian (or, Grecianese). The Irish are going Grecian. They are accepting austerity (a depression with debt deflation and high real interest rates) to stay in the good graces of lenders. So long as the U. S. can keep adding to its debt with central bank money created out of thin air, a la Japan, said debt replacing income to the government coming the traditional way from private sector taxes, then interest rates can continue to trend down. If that happens, then the long end of the yield curve will break to very low levels, no matter how high traders price the yields now. With 3-month T-bills at the same level as Japan's, at a trivial 0.12% annualized yield, that's my working hypothesis now.

At some point, however, the Grecian phase of a debt crisis can come to America.

Got gold?

Copyright (C) Long Lake LLC 2010

Wednesday, November 10, 2010

Will the Next Recession Look Different from the Last One? (Assuming the Last One Has Ended)

Mish has a post up involving a discussion with a Cerdian economist named Ed Leamer. I am going to comment on one point:

Leamer: Dips come from collective postponement of the postponeable purchases: homes, cars and equipment. But all three of these are at record lows relative to GDP after all the postponement that has already occurred. (After having falling to the floor, the economy has to at least get back to its knees before it can fall again.)

The dip Dr. Leamer is referring to is a new recession.

I wonder if his thinking reflects conventional thinking. I also wonder if when the next recession occurs, it will again fool the experts who are thinking as Dr. Leamer things and thus will not foresee it because it occurs on the less cyclical consumer spending side of the economy.

Meanwhile, we had a turnaround Tuesday today. Gold and silver reversed, and perhaps the record or near-record spreads on the yield curve out to 30 years have peaked. In the meantime, given the collapse in the fraction of the potential labor force that is actually working, we may simply see a combination of a continued retrenchment in consumer spending (especially that which is not due to government transfers/money-printing) and a government in financial straits pulling back on its support of housing. Plus, oil prices have been known to spike unpredictably. What would that event due to auto sales, travel and the like.

In the meantime, BofA ("BAC" symbol) fell 2 1/2% today, sadly once again hitting resistance at its declining 50 day moving average. The nearby chart tells the tale. It is one thing when gold or AAPL, in confirmed structural bull markets with prices that have been bid up fast and high, sell off. It is another thing when a laggard in a lagging industry helps lead the market down following a surge to overbought and over bullish levels. Informed people such as Chris Whalen of Institutional Risk Analytics have been stating that BofA is insolvent and needs to be taken under government protection with its bondholders taking haircuts. The government presumably would make great efforts to avoid this, given the effect on confidence such an action would have at this stage of the so-called recovery.

If Mr. Whalen is more or less correct, then the "Japanification" of the United States continues with seriously impaired major financial instutions existing as zombies ("too big to fail"). The 5-7 year notes are at or near all-time record low yields except for the past week or two. Who knows, but as the banker to the world, all the U. S. has to do is stop importing all elective things and the world will run short of new dollars. Thus I suspect that for all the moaning elsewhere about QE2, overall most of the rest of the world is happy to see America poorer and getting ready to ship its products to them rather than taking the fruits of their labor in return for our depreciating paper. Barack Obama predicted that the world would not let us live in our big homes wasting carbon-based fuels during his campaign. Meanwhile, though, there simply is no other currency ready to take the dollar's place as a reserve currency. (Gold will have to wait. The world is not ready for it yet.)

If he was correct on that in one way or another, please don't be surprised if the U. S. joins Japan and suffers a new recession despite zero interest rates.

Copyright (C) Long Lake LLC 2010

Monday, November 8, 2010

Two Contrarian Reasons to be Bullish on the Long Bond

Based on certain precedents, we may just have top-ticked the long bond, or may be within months of a top to be followed by a major drop in long rates.
(See the accompanying long-term chart of the reintroduced 30-year bond from the late 1970s to present; click on chart to enlarge.)

As of Friday's close, the spread between the 2-year bond (note) and the 30-year bond's yields were about equal to the post-1980 highs seen in November 1992, November 2003 and midyear 2009. These three times all afforded both good short-intermediate trading opportunities as well as good total returns on a 1-2 year time frame.

The first two of these occurred when the fear of price inflation had been stoked by Fed easiness post-recession. Interestingly, last year's peak spread occurred more or less exactly at the trough of business activity when there was great anxiety about the inflationary activities of all the various Fed and Democratic interventions.

Interest rates are related to business confidence. When business confidence is low and the profit picture is poor, it is likely that this mood will be reflected in low bonds yields and not high stock prices. Thus it is a very interesting fact (factoid?) that Bloomberg reports that earnings estimates by stock analysts ("analysts" is my point of view) have just set a survey record. From the article:

About 1.5 U.S. companies boosted earnings estimates above analysts’ forecasts for each that cut projections in October. That’s about three times the average of 0.59 in the past 10 years, data tracked by Bloomberg show. The ratio fell to a record low of 0.1 in December 2008, three months after New York- based Lehman Brothers Holdings Inc. filed for bankruptcy. When it reached 1.1 in March 2004, the S&P 500 rose from 1,126.21 to a record 1,565.15 in October 2007, Bloomberg data show.

(Presumably March 2004's ratio of 1.1 was the prior record.)

Long interest rates continued upwards for a few months after that March 2004 record, but to conservation at the Fed and probably in the popular mind, there was a "conundrum" as the Fed began raising the Fed funds rate in June 2004 in response to optimism on the economy. The yield on the long bond started falling and in a year or so from the start of the modest rate-raising cycle, fell to about 4.25% from about 5% at the end of March 2004.

The Bloomberg article happens to precisely delineate the precise wrong time to hold the long bond: when businesses are very gloomy and there has been a flight to "safety" in Treasuries. It was in December 2008, when there were pictures of Depression-era soup lines in the popular media and virtually all profit estimates were being downgraded, that the long bond's yield briefly went under 2.6%. Time to not be an owner; and on more than a few month's perspective, a great time to buy stocks. The stock market averages are up about as much since December 2008 to now as in the 3 1/2 years following a lesser degree of up/down earnings revisions seen in March 2004.

When optimism among businessmen is the order of the day per the Bloomberg article and fears that the Fed is buying way to easy as judged by the 2/30 yield ratio addressed at the start of this post, one way to be a bit of a contrarian is to buy a long-term Treasury bond (or bond fund) with the intent of selling it for a capital gain plus the interest payment that far exceeds returns available to cash.

I buy "off-the-run" rather than on-the-run Treasuries. Where appropriate, such as in an IRA, I also buy zero-coupon Treasuries rather than par bonds because of the combination of higher yields and greater capital gain potential should rates drop (of course, there is equally greater potential for loss if rates rise, but my game plan in that case is to be patient and not to sell at a loss).

A review of the chart above shows about a 3-decade bull market in Treasury bond prices; that is, steadily declining yields. Bulls on the stock market cannot point to a 3-decade-long secular bull market in stocks. Meanwhile, with rates everywhere from rates on cash to the 5-year bond at all-time record lows, and the 3-month T-bill exactly equal to that of Japan, who is to say that the record of a 36-year secular bull market in bonds will not be met or exceeded?
Because of its duration, in a way the yield on the long bond is a sentiment-driven instrument in some ways similar to the influences on speculative, unprofitable stocks. No one knows the future; place your bets. Recent history suggests that when it looks as though the business cycle is going to turn sharply as reflected by very high yield differentials between short-term and long-term Treasury yields, the contrarian buyer of the long bond has had good trading opportunities in a reasonable time frame or of course has been able to hold the bond and reap the income plus own an appreciating asset.
Nothing herein constitutes investment advice, and as in other posts on this subject, I would emphasize that the long-term Treasury represents a somewhat speculative investment in my view. I use it as a balancer within the portfolio as Treasury yields tend to bottom (and thus bond prices top) when stocks and perhaps precious metals have had significant drops.
Copyright (C) Long Lake LLC 2010

Saturday, November 6, 2010

Government Misstatements About Billionaires and Other Gold-Friendly Actions

To me, the most important news of the week may well have been the following:

‘Invalid’ Forms by Supposed Billionaires Skew U.S. Wage Figures:

Nov. 2 (Bloomberg) -- The Social Security Administration asked its inspector general to investigate how a $32.3 billion mistake skewed its statistics on 2009 wages in the U.S.

Two people were found to have filed multiple W-2 forms that made them into multibillionaires, an agency official said yesterday. Those reports threw statistical wage tables out of whack and, in figures released Oct. 15, made it appear that top U.S. earners had seen their pay quintuple in 2009 to an average of $519 million.

The agency yesterday released corrected tables that showed the average incomes of the top earners, in fact, declined 7.7 percent to $84 million each.

This was brought to EBR's attention by Zero Hedge. The New York Post added a bit of detail:

The erroneous information inflated total earnings for people who made over $50 million to a total of $38 billion, compared to a mere $12 billion in 2008.

When the data first emerged, it set off a firestorm and created the impression that rich folks lined their pockets at record levels in the midst of the Great Recession.

In other words, did the Obama administration invent, or ask the IRS or Social Security to invent, the numbers for political reasons?

In a similar but less egregious vein. the monthly employment report headlines were of about 150,000 private sector job gains. Ignored by the mainstream press was the Household Survey report showing about 330,000 jobs losses. In fact, the economic analyst Greg Weldon has reported a graph suggesting that the pace of job losses over the past several months as per the Household Survey is now at recessionary (double-dip) levels.

In any case, per the lead-in news above, why bother with government data anyway?

If you look at, there is a minimal trend toward improvement in the hiring/not hiring survey of workers. In the winter and spring of 2008, when the unemployment rate was rising, the difference was about +30 (this has dropped off the screen on the Gallup site). The level was about zero when there were hundreds of thousands of job losses per month at the worst of the recession. Thus average working people are seeing continued job losses, most likely. Certainly the Establishment data is likely skewed, I would hope inadvertently due to "survivor bias" and other factors.

Finally, the 5-year T-note dropped to all-time lows this week and remains there at the Friday close. Given that the 7-year note is around a pitiful 1.7% and the 30-year over 4.1%, we have a record upward-sloping yield curve in percentage terms (30-year yield divided by the 2-year or 5-year yield) and perhaps the 10-30 year absolute difference is at a record as well. Yet think how much can happen in 7 years. Think 1926-33; 2001-2008; 1967-1974; 1915-22. What happens beyond 7 years and definitely beyond 10 years is utter speculation.

What is definitely, definitely not in the bond market is that the yield curve over the past couple of years has followed the Japanese example to a 'T' to the best of my (imperfect) knowledge. First, very short term rates go near zero. Then the 6-month bill, then the 1-year note, then the 2-year note succumb and drop to progressively lower lows. Then the 5-year note succumbs. Eventually the 10-year and then the 30-year follow.

Remember that Gentle Ben can say whatever meaningless things he wants about the stock market and expectations. It's all verbiage. As John Mitchell said, watch what he does. That's all that counts. And he happened to announce a monetization quantity about equal to the projected Federal deficit. Thus no foreigners or even American citizens need to add to their Federal debt holdings. I assume that just as Paul Volcker is reported by Martin Mayer in "The Fed" to have promised the Reagan team that he would play ball with a pro-growth agenda in return for renomination as chairman, Dr. Bernanke agreed with Team Obama to monetize as much debt as needed in return for his full term.

The public will now likely add to its already large stock positions, believing the nonsense that more money-printing will stimulate anything except price increases as well as the Bernanke overt statement that the Fed is now targeting higher stock prices. One would think that stocks related to oil and precious metals will now have a new tailwind. I mentioned HP (no, not Hewlett-Packard), the oil driller Helmerich & Payne, several weeks ago. It is a high-quality outfit with technologically very advanced land drilling rigs ("Flexrigs") that is way off its 2008 stock price highs. With oil prices on the rise but historically a bit undervalued vs. gold, we could see much higher prices for this stock and its peers in the months ahead.

Oh- and the Republicrat/Demopublicans shifted some D's for R's. The good news is that tax rates look to be staying down. The bad news is that there is no sign that government spending will be cut to fund the tax cuts. If it plays out that way, that's a lot more $$ of debt for the Fed to monetize and thus gold prices will be goosed yet higher/faster. Further bad news is that the incoming head of a relevant House committee, Spencer Bacchus, wants Big Finance to keep its proprietary trading divisions and thus wants Dodd-Frank ("Finreg") to have a Big Finance-friendly regulatory interpretation. As if Tim Geithner will object to anything for his friends in Manhattan.

With immense uncertainty and relatively limited dollars at risk, I continue to believe that by hook or by crook, the Feds will continue the 29-year downtrend in long-term interest through a captive financial industry as intermediary. In the meantime, stagflation remains my base case and therefore I continue to believe that despite the massive run that gold has had since its summer low, the trend remains upward. This is to say that I believe that the trend of the value of a dollar remains down. As I have said over and over, gold as a store of wealth is boring. It just sits there. The Fed can invent all the excuses it wants to do the opposite of what the Volcker Fed did for almost 3 years (Oct. 1979-August 1982) and keep short-term interest rates inappropriately low. My guess is that unless and until actual declines in consumer prices occur in a sustained manner while the Fed uses its command and control power along with its influence as conductor of the global financial orchestra to be way too easy in its monetary policy, the precious metals market and probably the oil market will remain in meaningful uptrends.

The Dow is up about 12% in the almost 6 1/2 years since the FOMC raised the Fed funds rate in June 2004. Add dividends and perhaps you have 5% per year appreciation with a lot better buy-in points than 2004. Gold meanwhile is up from about $400 to about $1400/ounce. The Fed quelled the price rise of gold in May 2006 when it increased the Fed funds rate to 5.0%. At that time the CPI was peaking around 4% but soon dropped to under 2%. With monetary stimulus on overdrive, bailouts everywhere, politicians pandering to most interest groups except savers, I anticipate negative interest rates on the short end to get even more negative. One of these days, I expect pension funds and the public at large to get gold. Most people just don't "get" how with "inflation" reported as "low" gold can go up so much for so long. But, as Galileo might have whispered under his breath, the correlation of rising gold prices with too much Fed ease just keeps on working.

We are nowhere near a bubble in gold prices. We are however looking at a U. S. government that may have invented tax numbers for political reasons. But it can't invent physical gold.

Copyright (C) Long Lake LLC 2010

Monday, November 1, 2010

Financials Under Stress

It's a bit pat to look at a sell-the-news down-move in stocks following what might be a major-league blowout election for the Repub side of the Republicrat/Demopublican Party and then the Fed meeting with potential friendly moves for financial assets, but more immediate adverse things are happening. A former blue-chip trust bank, Wilmington Trust (WL), more or less bit the dust today. It is of concern as a possible canary-coal-mine sign of lots more undisclosed problems with the asset base of other financial companies.
The details are a tad disturbing. The company announced quarterly results today, which revealed massive losses in its commercial real estate portfolio. Book value collapsed. The stock, which was $20 in the past year, is now at tangible book value under $4.

Simultaneously, an acquirer was found. This was not just any old acquirer. It was M&T Bank (MTB), which is 4.5% owned by Warren Buffett's Berkshire Hathaway (symbol BHK-A or BHK-B; BH for now). BH was a major beneficiary of the 2008 financial crisis, helping to bail out Goldman Sachs on much more favorable terms than the administration negotiated on behalf of the taxpayer. I suspect this was a political deal to quietly hand M&T to BH. Whether this was a favor owed by BH to Treasury and therefore was done above market value, or whether this was another gift to BH, or neither, cannot be known by yours truly.

Wilmington Trust has now collapsed below its bear market low. This is serious and so far as I know comes out of the proverbial nowhere. You may have noticed that Ambac is near bankruptcy as well, news that also broke today. The ticker symbol for Ambac is ABK. It might as well be BK!

Meanwhile, milder problems surfaced in the financial world. JPM is being scrutinized by the SEC regarding a mortgage securitization. The venerable Metlife has disclosed irregularities in its mortgage servicing division, and the division of Goldman Sachs that is a large mortgage servicer is on a credit downgrade watch.

Meanwhile, some measures of optimism about the stock market have reached very high levels just as insider selling has also reached extremes.

All this occurs as the 2-year Treasury yield is mired at new lows not only for this cycle but since the Great Depression at a Japanese-like 0.34%. I am told that this is more or less a free-market rate rather than one imposed by the Fed. Thus some very smart, large and serious money is leaving a lot of income on the table by hiding in 2-year Treasuries rather than buying the Dow at a much higher yield. Thus this vast pool of money at the very short end of the curve is implicitly saying that stocks are seriously overvalued, and that the dividend payout will largely be offset by price declines.

If one were to overlay the 5-year price charts of BofA (BAC), WL, and ABK, one might be interested to note that they have the same pattern as the chart of the 10-year bond.

When I discuss these matters with my financial professionals and the "investor on the street", the overwhelming consensus is that it the very long term Treasury bond is the riskiest and worst investment around. People are accepting gold more than the long bond.

What may well happen is that with WL stock collapsing overnight, it is clear that tangible book value in financial companies is meaningless. Thus there is no solidity to any banking company's valuation. All are suspect. We know that Citi was a goner in 2008 if not for the taxpayer, and BofA was close. The failure of the housing and commercial real estate markets to rebound mean that the real estate depression and the vast amount of securities tied to it looks to be acting as an undertow against the natural tide of economic expansion in a country with a growing population.

One has to be patient with macro events. ABK helped touch off the financial crisis in late 2007, when it and other similar companies were found to have insured garbage securitizations. Yet only three years later does it look to be dying.

GM was dying for years, but the final stock collapse came rapidly.

Ripeness may be all, but when will the fruit fall from the tree and then start rotting?

Dunno, but with regard to my contrarian speculative position in long Treasuries, I did see a headline I liked today on Yahoo's Finance section. It was the banner headline by the stock summary. It said something like: "End of the 30-year bond rally".
That might be like ringing a bell at the end of a move. The 30-year bottomed in yield in 2003, at the bottom of the short and long term interest cycle, at 4.10%. Sixteen or so months past the (alleged) end of the recession, it would fit my sense of symmetry if the yield, now at 4.02%, respected that 4.10% level as important resistance.

About a year ago, when long-term rates were much higher than now but ZIRP was well ensconced, I bought long bonds and commented to the broker to the effect that the Government wanted to run large deficits and would probably-- somehow-- engineer lower rates to help pay for them. Without knowing how, please look at this chart of the 30-year Treasury bond since inception in the late 1970s. Is it not possible that there has been an invisible hand leading the yield lower?
The current yield is seen to be around the downtrend line one's mind's eye can draw starting around 1981. (Click on the chart to enlarge.)

And with the 2-year Treasury having joined the 1-year note as well as the yet shorter-duration T-bill market at new lows for the cycle and showing no current signs of upward pressure, the outlier is the much smaller and volatile long bond market. Thus sentiment can change rapidly, because while we think we know the price changes coming down the pike the next few months, what happens years from now is pure conjecture.

All we need is one mini-crisis in the banking sector to drive yields a lot lower in the 10-30 year range; or, serious buying of the long bond by the Fed. Who knows, but the downside of holding said bonds to maturity is not the end of world unless the financial world actually ends via hyperinflation; and to that possibility I say: got gold? The upside of being correct on a bond purchase for a trade is however significant even if one simply has to metaphorically clip coupons for a year or five.

Copyright (C) Long Lake LLC 2010