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Friday, June 20, 2008

Hindenburg Omens: I am Bear, Hear Me Roar

I am BEAR, hear me ROAR.

Since the S&P hit 1440 and broke DOWN and OUT of the Bear Wedge, things have gotten ugly quickly for the Bulltards. Losing the 1332 area will result in another round of selling…

The Three Hindeburg Omens Since June definitely aren’t a good sign for the Bulltards. A cluster of seven omens actually preceded the plunge to ‘lock limit down’ at 1255 where Ben ‘Helicopter’ Bernanke stepped in with his first surprise, emergency 50 basis point rate cut.

The Hindenburg Omens would have got you out of equities way back in November when I posted 5th Hindenburg Omen in this Cluster. Those of you with quick trigger fingers could have escaped your long positions when the first three omens printed consecutively on Wednesday, Thursday and Friday in October in Hindenburg Omen.

If you’re thinking WTF is a Hindenburg Omen? Click here.

For a while there the Bulltards grew complacent as they believed in their Great Savior Ben ‘Helicopter’ Bernanke. No longer.

Using the ProsShares Ultra Short S&P 500 (SDS, candle) to represent the inverse of the S&P 500 and plotting the price action against the volatility (VIX, grey area) the positive correlation between the two becomes crystal clear. As VIX falls, the market rises. Conversely, extremely high VIX readings in excess of 30 tend to set bottoms (in the case of SDS, tops). A reading of less than 20 on the VIX now, probably represents extreme complacency for this type of environment. I would therefore expect and look for general equity weakness.

Pre-Crisis Levels:
VIX < 15. Farm animal stupid levels of complacency and risk taking. The VIX actually dropped into the single digits as easy credit and 'liquidity' fueled the greatest and dumbest credit and real estate bubble to date...

Crisis Levels:
VIX < 20. Crazy, irrational complacency as the largest credit and real estate bubbles ever implode. Bulltards are content, massively long and leveraged to the tits. Equities are likely to absolutely shit...

VIX > 30. Crazy, irrational fear. Equities likely to bottom short term… although the VIX can and has spiked much further in the past when the ‘wheels finally came off’.

With the Fed Funds Rate now at 2.00% and oil mocking Bernanke from the lofty heights of $139.89 the Fed is starting to look impotent. The Fed balance sheet is rapidly being depleted and now consists mostly (54%) of ‘toxic junk that nobody else wants’. In the Fed’s Balance Sheets Shares by Facility the rapid and CONTINUED deterioration of the financial system is clearly obvious.

In March I warned the Fed is Almost out of Ammo: “The Fed has almost run out of ammo. Much like George Soros on Black Wednesday, when he ‘broke the Bank of England’, global capitalists are damn near close to breaking the Fed. 60% has been committed and it doesn’t seem to be working. Another push and things could unravle quickly...”

Just because things look scary now, doesn’t mean they can’t get worse… Scary Fed Charts: JUNE, ‘Just’ 1% of GDP Now.

MBIA and Ambac are Dead, Fannie Mae and Freddie Mac are Next

MBIA (MBA) and Ambac (ABK) are finally dead…

Bill Ackman Was Right: MBIA, Ambac on `Ratings Cliff' (Update1): “Bill Ackman was right: the world's largest bond insurers aren't worthy of a AAA credit rating and may be headed for the bottom of the scale.

Ackman, the 42-year-old hedge fund manager who says he stands to make hundreds of millions of dollars betting against MBIA Inc. and Ambac Financial Group Inc. if they go bankrupt, will tell investors at a conference in New York today that losses posted by bond insurers may threaten to breach the capital limits allowed by regulators, making them insolvent.

That once-unthinkable scenario would trigger clauses in $400 billion of derivative contracts written to insure collateralized debt obligations and other securities, allowing policyholders to demand immediate payment for market losses, which have reached $20 billion, according to company filings. Downgrades of the insurers would cause a drop in rankings for the $2 trillion of debt that the companies guarantee, wiping out the value of the CDO insurance held by Wall Street firms, analysts at Oppenheimer & Co. said.”

All the monolines will now implode, one after the other…

“CIFG North America may fall first. The company's credit rating has been cut by 17 levels to CCC from AAA by Fitch since March because of concern it won't be able to make payments on $57 billion of the contracts.”

You are the weakest link. Good-bye.

“MBIA, of Armonk, New York, Ambac, Security Capital's XL Capital Assurance and FGIC Corp. also have guarantees with similar clauses to CIFG that may allow policyholders to demand billions of dollars if the companies became insolvent, according to company filings.”

These clauses are going to go off in rapid succession. The broader equity market is not going to take this well at all…

Ackman Foresaw MBIA Drop, Is Short Financial Security (Update3): “Hedge fund manager Bill Ackman, who correctly predicted shares of MBIA Inc. and Ambac Financial Group Inc. would tumble, said he now is betting against Financial Security Assurance Holdings Ltd.

Financial Security may be insolvent because it sold investment contracts backed by mortgage securities that have tumbled in value, Ackman, 42, told a conference hosted by law firm Jones Day yesterday in New York. Financial Security, a New York unit of Brussels and Paris-based Dexia SA, is one of two bond insurers to retain their AAA credit ratings after rivals were roiled by losses from collateralized debt obligations.”

Ackman is now targeting the last ‘strong’ insurer.

Freddie Mac, Fannie Mae to Post More Losses, Lehman Says: “Fannie Mae and Freddie Mac, the two largest sources of U.S. home loans, may post further losses in the second quarter as the housing market continues to deteriorate, Lehman Brothers Holdings Inc. said.

The brokerage changed its forecasts for operating losses for Fannie Mae to $1.20 per share from a prior estimate of a loss of 68 cent, and lowered its projection for Freddie Mac to a loss of 55 cents per share from a prior forecast of a loss of 40 cents per share.”

I am going to say it right here and right now. Both Fannie Mae (FNM) and Freddie Mac (FRE) will go the way of MBIA (MBA) and Ambac (ABK)… They are next. It is inevitable.

They are similar enough. Tiny equity and cash bases that can’t possibly sustain a ridiculously large and overleveraged portfolio of extremely poor quality…

I have repeatedly advocated using Fannie Mae and Freddie Mac as Disaster Insurance. Update1. Using LEAPS (Long Term Equity Anticipation Units) you can implement a simple, cheap and effective disaster hedge for a portfolio of any size.

Thursday, June 19, 2008

Oil Drops on Subsidy Cuts in China, India, Malaysia, Taiwan

Oil Falls More Than $4 as China Announces Fuel Price Increase: “Crude oil fell more than $4 a barrel, the biggest drop in 11 weeks, on speculation demand will decline, after China said it will raise fuel prices starting tomorrow.

China, the second-biggest fuel consumer after the U.S., will increase gasoline and diesel prices by 1,000 yuan ($145.50) a ton, the National Development and Reform Commission said. The increases represent a 17 percent gain for gasoline and 18 percent for diesel. Gasoline, natural gas and heating oil also fell.”

That should put the brakes on the Chinese economy…

This is the catalyst that will finally burst the oil bubble. India, Malaysia, Indonesia and Taiwan have increased fuel prices and reduced subsidies this year. This will have an immediate effect on fuel consumption in these nations because they really are marginal consumers and are therefore the most price sensitive.

In Dollar Smile, Global Decoupling, Oil Super Spike and Yields I argued:

“Increased demand from developing nations won’t drive oil much higher. Developing nations are the new marginal consumers. That is to say they are the most price sensitive elements of oil demand. For first world nations oil demand is very inelastic. For developing countries oil demand is far more elastic. That means for every $1 increase in oil, more demand will be choked off in developing countries than in first world countries.

Translation: Long before high oil prices cripple the SUV driving commuter making $48 201 (2006 US median annual household income) the Chinese factory worker making about $7 700 (2006 Est.) or the Indian worker making $3 800 (2006 Est.) will have given up on certain consumer amenities.

It is a serious mistake to assume that commodity prices at these levels won’t have a serious affect on these developing nations.”

The Shanghai Stock Exchange Composite has dropped from a high of 6 124 to 2 748 or 55%. Like all bubbles, this index first went parabolic, and then imploded twice as quickly…

The smart money was well aware of the extreme strains the gasoline subsidies put on government budgets. The smart money got out, knowing full well that it was only a matter of time before the spot price of crude and gasoline would force these governments to back off on their subsidies. The effect on both consumption and economic growth will be severe by virtue of the fact that the average Chinese or Indian consumer has far less disposable income to shuffle about. Fuel price hikes will take very real and immediate chunks out of their discretionary spending budgets.

Seriously, what did you think would happen? Come on, you didn’t really buy into the ‘Chinese are putting a million cars a month on the road’ hype? That demand in Asia would skyrocket even at $130 dollars a barrel because they’re a ‘super hyper growth ninja economy’? In the end, somebody has to pay. For a while it was the Chinese, Indian and Malaysian tax paper. But now that these subsidies have become ridiculously huge, the government has STARTED to shift the burden to the individual consumer. I say STARTED, because there are far more subsidy cuts to come…

The cure for high prices is high prices.

From my post Parabolic Commodities, The End is in Sight:

“This is all you need to know: PARABILIC = END IS NEAR.

First: When The Momos Go Parabolic…
Second: When The Momos Lead The Way Down
Thirdly: Life After Things Go Parabolic, This Bounce Too Will End.
Most importantly: All Bubbles Are The Same

I’m a big fan of Peak Oil Debunked. (Don’t freak, I am aware that oil is a finite resource that will peak someday… but that day isn’t even remotely close.)

Related Posts:
Damit, Why Won’t You Learn?
From Bubble To Bubble: More Hidden Losses
The South Sea Bubble and Today’s Central Banks: FRB, BOE, ECB

The Food Crisis: Stuffed and Starved

A great book to read about the ‘food crisis’ is Stuffed and Starved by Raj Patel.

Free Trade in Food Is `On the Ropes' Amid Shortages, Price Rise: “Free-trade policies long advanced by World Bank President Robert Zoellick and U.S. President George W. Bush are losing favor as countries in Africa, Asia and Latin America find they can't buy enough food to feed their people.

Global food prices have spiked 60 percent since the beginning of 2007, sparking riots in more than 30 countries that depend on imported food, including Cameroon and Egypt. The surge in prices threatens to push the number of malnourished people in the world from 860 million to almost 1 billion, according to the World Food Programme in Rome.

Leaders of developing nations including the Philippines, Gambia and El Salvador now say the only way to nourish their people is to grow more food themselves rather than rely on cheap imports. The backlash may sink global trade talks, reduce the almost $1 trillion in annual food trade and lead to the return of high agricultural tariffs and subsidies around the world.”

I recently brought up free trade in Here We Go Again: Free Trade Era Dieing. It looks like free trade in food is now being targeted.

Firstly, trade in agricultural products has always been the least ‘free’. Tariffs and subsidies are still rampant the world over. For example, in Japan nearly all imports of cheap foreign rice from countries like China and America are blocked. The government then pays the farmers at least four times the market value for rice and then sells it into the market at a loss. So to rage about free food trade policies being responsible for shortages and price spikes is just absurd.

Second, a free market will match supply and demand up at any given moment in time. Granted, the market clearing price might be anything but pleasant, but to say that “…countries in Africa, Asia and Latin America find they can't buy enough food to feed their people” is ignorant. What is really meant in that complaint is that these countries can’t purchase enough food at LOW prices. They can’t or don’t want to pay the market clearing price. Since they are poor or developing countries it is entirely possible that they do not have the economic resources to pay for expensive food imports. That is an entirely different and separate matter.

Third, to say that “the idea of trade liberalization was that you could count on global markets, but they're not proving reliable” is also ignorant. The global markets are completely reliable. The supply is there. The real issue is at what price. That statement also implies that somehow tariffs and subsidies would prove reliable. That is something only the economically illiterate could believe. Tariffs reduce or prevent imports. Subsidies reduce or prevent exports. These policies completely discourage trade and do not address the problems of nations that must import food.

Finally, the most important point here is that the free market price is a valuable signal. Price is THE MOTHER OF ALL SIGNALS. For the first time, in what I can only guess to be several generations, farmers are actually able to earn a respectable living. These prices make it possible for farmers to plant more and invest more in productivity enhancing technologies and equipment. That is exactly what they will do. The profit motive will encourage them to do so.

These higher agricultural prices will result in other VERY important benefits. These are called economic externalities. For example, now that there is money to be made in agriculture, farm land will increase, or has increased, in value. The free market has made it less likely that productive farmland will be converted into residential real estate as the opportunity cost of doing so has now increased. The long run benefit of being able to make a normal economic profit (This is an important term, not likely to mean what you think it means. Follow the link, look it up) in agriculture means that non-agricultural development will emphasize non-productive or marginally productive agricultural lands. This is an important shift for all of humanity away from buliding our greatest cities on the most fertile of farmland.

I would actually argue that prices have been ARTIFICIALLY low. By my definitions and understanding of economics, if producers can’t make a normal economic profit, then the market price is too low. Since that would normally dissuade these producers from producing (by exiting the business for example), prices would rise as supply is withdrawn. That this did not happen for generations is the result of massive global tariff and subsidy policies.

As explained by Raj Patel in Stuffed and Starved, there are very real problems in the food supply and distribution chain that are the real culprits. It is because of these problem that market prices are being unduly influenced. Clear these bottle necks out and the entire landscape would change for the better...

Wednesday, June 18, 2008

Three Hindenburg Omens Since June

Robert McHugh reports another cluster of Hindenburg Omens. There have now been three since June 6th.

Directly from HeadlineCharts who caught it first:

“The chart above captures the notes published by Robert McHugh. I follows his comments because he has excellent charts even though he is a Chistrian, doomsday market timer. Nothing against Christians, or even doomsdayers, I just don't want these views confused with honest market analysis.

McHugh is big fan of Hindenburg Omens and is constantly watching for them. As the name implies, they aren't good, and therefore fit in perfectly with his view of the world.

Unfortunately, there have been three since June-6. Apparently, one Omen is a warning, but two or several close together is a confirmed Omen with very negative implications.

Once again, cash is king.”

The S&P 500 chart is from HeadlineCharts.

Everything you ever wanted to know about the Hindenburg Omen:
The Ominous Hindenburg Omen

Tuesday, June 17, 2008

India: The Riskiest Market

India is the most expensive (over valued) emerging market…

Hang Around 73 Years for Final Check From India: Andy Mukherjee: “Markus Rosgen, a Citigroup Inc. equity strategist in Hong Kong, has turned the commonly used metric of dividend yield on its head with interesting results.

The inverse of dividend yield is, of course, the price of a share divided by its most recent payout.

The measure can be thought of as a dividend-payback period, with a 5 percent yield implying a 20-year horizon for return of capital to the investor discounting any gain or loss from a change in the stock price.

“The concept is simple,” Rosgen says. “Assuming no increase in the payout ratio, no rise in dividends, how long will it take investors to get the current outlay back in the form of dividends?”

Well, the answer is almost 73 years for the MSCI India index, which makes the third-biggest Asian economy “the most expensive market in the region,” Rosgen and his colleagues, Elaine Chu and Brian Li, said in a report yesterday.

When the outlook for capital appreciation is clouded -- as it is now, by high food and fuel prices, a global credit crunch and dinner-table talk of stagflation -- it's quite natural that investors will look for stocks that have more assured payoffs.”

A couple of the more interesting findings are that Pakistan (16 years) and Taiwan (22 years) as more attractive than not only India, but also South Korea (54 years) and China (39 years).

A 1991 study titled “The Equity ‘Yield Curve’” concluded that in uncertain times investors would rather own a short payback asset.

Translation, by this measure India is at the greatest risk of a significant correction because of the large 73 year payback period.

The assumption of course is that these are uncertain times…

I last mentioned India in Fibonacci Heaven and Update1.

Monday, June 16, 2008

Here We Go Again: Free Trade Era Dieing

After the easy credit of the Roaring Twenty’s ended ever so suddenly with the Wall Street Crash of 1929, economically illiterate politicians of every major nation turned suddenly and vehemently against Free Markets and Free Trade. A confused, scared and angry electorate eagerly pushed for the very policies that would result in a global recession and national depressions. Despite the signed protests of one thousand twenty eight economists, the first of many suicidal policies implemented was the Smoot-Hawley Tariff Act. The Federal Reserve System then followed up with a tight monetary policy, thereby landing the mortal blow to both the U.S. and global economy. Retaliation began long before the bill was enacted into law in June 1930 as one country after another moved swiftly towards autarky.

Farm animal stupid, but here we go again:

Free-Trade Era May Be Nearing End Amid Food, Growth Concerns: “After six decades of ever-expanding international commerce, the high tide of free trade is ebbing.

As tens of thousands of South Koreans protest U.S. beef imports, rising commodity prices push nations to keep more food for domestic consumption and the U.S. chooses a new president who might be less supportive of free trade than his immediate predecessors, the world may be facing the end of a cycle that began in the immediate aftermath of World War II.

The liberalization of global trade has come “to a screeching halt,” said Fred Bergsten, director of the Peterson Institute for International Economics in Washington. “It'll take years to rebuild the foundations of free-trade policy.”

The cause is more political than economic.

Fueling the backlash is a convergence of trade-related anxieties: national-security concerns, worries about food safety and sufficiency, the desire to protect local jobs and the environment. In addition, the benefits of trade are often widely dispersed -- think low prices at Wal-Mart -- and entail high adjustment costs, including the loss of manufacturing jobs.”

Now as the GLOBAL credit and real estate bubbles deflate you’ll here more talk of this nature:

“Meanwhile, Democratic presidential candidate Barack Obama says that if elected, he might reopen the world's largest trade deal, the North American Free Trade Agreement with Canada and Mexico.”

Since Barack Obama is a clever fellow, this is probably nothing but a vote grab for him… and something he won’t actually follow up on.

BUT when the masses rage, anything is possible…

“Nowhere is that more evident than in South Korea, where public anger related to a pact aimed at increasing trade with the U.S. by 20 percent is shaking the government of President Lee Myung Bak. Lee has seen his popularity plunge from 50 percent when he took office in February to 17.1 percent in a poll this month by Korea Research and the YTN cable news network; his cabinet this week offered to resign over the dispute.

On June 10, about 80,000 South Koreans flooded the streets of Seoul to protest a proposal to resume beef imports from the U.S. Korea must remove the five-year-old ban, which was designed to prevent the possible spread of mad-cow disease, before the U.S. Congress will consider approving the trade agreement, Senate Finance Committee Chairman Max Baucus of Montana said June 11.”

… anything is possible because votes are a politician’s kryptonite and the masses have a nasty habit of voting themselves straight into poverty.

What do you think will happen to emerging market economies and all those beautiful ETF’s should a couple of trade wars erupt? From Brazil, India, and China to Russia risky assets such as equities will get positively crushed…

When the going gets tough, the guy with the most outrageous ideas seems to get the most attention… and votes.

Housing prices going down? Don’t worry about it. Bail out the clowns that bought them, forgive the loans and freeze house prices.

Inflation pushing up prices? Freeze prices. Make inflation illegal.

Commodities going up? Blame speculators and tax the producers so they don’t go looking for more commodities… oh and, subsidize consumers so that supply and demand signals REALLY get messed up.

If that doesn’t work… find a scapegoat and go immediately to war.