Good to be back in Burbank

I came back from my trip, refreshed, and ready to read the responses I got from my letter to the Barron's authors. An empty inbox and a lump of coal in my stocking later, I still maintain high spirits because of my 12 confirmed blog followers. You all keep me up at my lowest moments. But, for those hoping I can show my gratitude by showering you with warm thoughts about gold, I am afraid you will be left disappointed. While I maintain my long term uber-bullish outlook, I just can't come up with the reason to step in and buy it here. Listening to technician Jeff Weiss on TV (I've met Jeff, he's a very nice guy) he warns that we are at a key point in the long term chart on GLD. As he put it, consecutive closes below 150 could be a real warning signal. So, for now, assuming we hold, perhaps we can make a case to buy. But unless we see that, you are working with significant downside risk, and little compensation for your upside.

Let's take a quick look at the story as its shaping up, and why I can be a short term bear and longer term bull. Gold is currently not a safe haven. I had thought that we might see gold regain its safety bid as the European crisis pressed on, but it looks like the dollar will steal the show. Despite an uncertain backdrop, sentiment has become more positive particularly with respect to US equities. All I seem to hear lately is how cheap US stocks are, how much cash the companies have, and how Europe has not brought down the US story. While some 40% (rough number) of S&P earnings come from Europe, optimism is maintaining strong footing (for now). But whether there is to be a pop in equities or not, our 10 year is still below 2% (even after our rally). My takeaway is that good stock market or bad, people want to have their money in US treasuries. I cannot say why, or that it makes sense, but that has been the trend and it has shown no signs of breaking.

The problem for gold is that the stronger dollar makes dollar denominated gold cheaper. If it is not perceived as a safe haven, than it will be difficult for gold to counteract the dollar's bid. But gold is an inflation hedge right? As my unanswered email points out, right now sentiment is not inflation fearing; rather the opposite. While we all know this is crazy, particularly given the mysterious rapid expansion of the ECB's balance sheet, for now, the environment is not inflationary (I have trouble writing that and believing I'm writing it). And besides, with this recent fondness for US equities, people will go with stocks instead of gold to counteract inflation.... especially with the expectation of continued dividend payments from cash rich stocks. Remember when gold was at 1200 on the way up and it seemed there was no downside scenario? If things were bad, gold was the safety play, if things got better, we were still printing, and that was good for gold. Now gold is in the exact opposite place. Nothing is good for it. If things are good, you'd rather be in equities. If things are bad, you'd rather be in treasuries. But this can't persist forever.

Treasuries do not have their best days behind them. Treasuries are the new gold, but that, like golds endless run up, will come to an end. If Kyle Bass knows anything (and we know he does), and if it is an indication of the systems fragility when we see as we do now that European banks are no longer lending to each other (and we know it is an indication) then we know that the likelihood of a liquidity crunch is high... and then? Print Print Print Print Print Print Print. If gold keeps getting smashed, it is highly probable that it will be at relatively depressed levels at the same time treasuries lose their luster. Then, the gold bulls can come back to the rodeo.

The Critical Market Perception... not if to delever, but whether to inflate or deflate

On the train out to Long Island this morning, I picked up this week's copy of Barron's. A lot came to light following just the first two pieces I read. Below, is a note I wrote to the authors, Jacqueline Doherty and Andrew Barry, of the second piece in this weekend's edition. The first, which I contrasted it with, was written by Alan Abelson. Below, is the greater part of the note I wrote to them. It speaks for itself.

Jacqueline/Andrew,

I wanted to write in response to the first part of your piece in today's Barron's, where you describe QB Asset Management's view of the pending "Face-Ripping" inflation. I thought it was a great touch (though I'm not sure if it was intentional) the way your piece directly followed Allen Abelson's recap of his conversation with Dave Rosenberg from Gluskin Sheff. Never do I think I have read two sequential articles show such stark contrast in thought. Mr. Abelson's piece concluded with deflationary outlooks, while yours began introducing the possibility of rampant inflation. The funny thing is, both the Rosenberg and QB outlooks are very reasonable arguments. However, I think we would be remiss to overlook this as a funny coincidence. Rather, we should recognize that this contrast in outlook might be an example of the most important debate to determine market direction in 2012.

Mr. Abelson writes in summing Rosenberg's thoughts,"it {"extinguishing debt"} will be accomplished by a combination of default and write-downs, debt repayment and rising savings rates. All of which, he warns, will tend to be very deflationary". In your article, you point out that "the QB duo is convinced that central bankers will start printing money to pay off public debts and keep the banking system solvent". QB makes a good case for just how hyper, hyperinflation could get by pointing out that "the system's base money (bank reserves at the Federal Reserve and currency in circulation) is dwarfed by the claims on it. When I Contrast the deflationary and hyper-inflationary cases that both sides make, I am more struck by the similarity in their tone than the difference. Both Rosenberg and QB are believers that an inevitable "face the music" moment with our over-levered system is soon coming. What they disagree about is the likely policy response the world will take when we get to that fateful moment.

The need to deal with this situation is looming imminently upon us; both QB and Rosenberg agree. But, will it be through the pain of taking our lumps to pay off these vast sums? Or will it be the money printing party that enables us to pay back our debts with money that is worth far less? Either way the deleveraging is taking place. And here we meet the fork in the road. We are forced to make a decision about whether we think it will be inflation or deflation. Last week's gold beat down really began following the uneventful Fed announcement. With few changes from the previous release, QE3 thirsty investors were apparently looking for some hints at stimulus. No easy money, gold gets smashed. And nothing really happened. As ridiculous as it is to expect QE pre-US recession (if there is to be one), last week showed us just how fickle the market is. Without a "hint" in the language of the Fed, that we "might" get some easy money on the horizon, and gold prices (which are highly correlated to inflation expectations) plummet. I think your article, contrasted with Alan Abelson's demonstrates just how central the market perception of inflation vs. deflation is to the world of capital markets.

Wrong on The Vixx

I got this one wrong; The vixx has continued to stay at depressed levels. While I continue to believe that this lull will likely end soon, and with a strong spike, for now the timing in my call looks pretty poor. If however, I were a money manager, I would be loading up on puts on the S&P. My stock market bearishness, which has now been here for some time, was only made stronger by reading Kyle Bass' December letter to investors (http://www.scribd.com/doc/75784106/Hayman-Capital-Letter-Dec-14). It is worth a read. A focal point of the letter is how investors' counter-party risk concerns are such that they would rather give up the yield they could attain by parking their shares at banks' for prime brokerage use (the banks would lend those shares to other clients looking to borrow stock) and put them at third party custodians. This lack of trust is the natural beginning of the de-leveraging process, one that even central bankers might not be able to contain.

Gold didn't quite plummet  100 dollars on Wednesday, but it came awfully close. As has been the case, the sell offs in gold are pronounced, while the rallies are slow. Today, we are seeing gold continuing to rally nearly every time it comes into the 1590 area. So what happened to the gold story? The problem for gold right now is that we're in a deflationary environment. The market wanted QE3, but didn't get it. Europe hasn't indicated that they will print money, and for now, that will keep a lid on gold. Eventually however, the story will change. When push comes to shove, the European countries will have no choice but to print, and inflationary pressures will re-emerge which is positive for gold. 

I will be away for the next week, but will be getting back to it upon my return. Everyone have a great holiday.

-Ben 

QuEstionable rumor

Trading near unchanged for the greater part of the morning, gold rallied 7 bucks in about a minute. A rumor that today's Fed announcement would involve hints of QE3 got people excited, as it should were it to have had any merit. I have noticed (though I believe the last reaction was pretty much null) that even if there is fairly bullish news, traders tend to sell gold after the announcement. Buy the rumor sell the event I suppose. Today's drop, while not precipitous from the outset began to really pick up momentum. 

The Fed announcement, which was made a little bit after 215 last time was actually made early today. So not only do we tend to be wrong about what the Fed will say, we can also be fooled about when they'll say it. In all seriousness, if you have a position on, its worth being by your computer a few minutes before the announcement. Why such a rumor would get out, or how it is possible that anyone with any inside knowledge would spread such a rumor is beyond me. But what is even more beyond me, (and I recognize I have hindsight here, but I have said this before) is why the Fed would ever make such a move now. Without anymore room to lower interest rates, and an increasingly small bag of tools left, it would seem that the Fed would probably rather wait until something got really bad, before it broke out the big guns.

Pre-announcement, Gold, which has been getting trashed like no other of late, was trading 1663. It then continued lower coming into the 1636 level, which is the 61.8% Fib retracement number (a number traders watch closely). As would be customary, bids came in at this level, pushing gold back into the low 40s, before it broke 36, trading as low as 1625.5. I thought we had a shot at 1617 (the approximate 200 DMA in gold) but apparently the selling had reached a temporary climax. we ended the session around 1634.

3 quick noteworthy points:

1) Dennis Gartman has liquidated his personal holdings in gold. This is no reason for hitting the panic button, but so far (very short term) he has been right, and the fact that gold has under-performed so much of late must keep us short term bearish. To put it simply, it just doesn't seem like anyone wants to buy gold (though the exception is there has been persistent demand for the physical... particularly from India of late)

2) The S&P closed below 1225. Last time we came tumbling down, the S&P was unable to make a close above 1225, which signaled a downward move. A close below 1225 tomorrow would be very bearish.

3) And 3 is less of a point, but do you ever wonder if maybe we haven't grown accustomed to Angela Merkel the way we should in America? Everytime she says something negative, like today, when the pop from the QE rumor halted post her comment they would not raise upper limits on the bailout fund, we sell off. While I am no German political expert, it would seem to me that Merkel uses the public sphere to help her gain leverage in negotiating. She always seems to say "no" to new proposals putting a damper on short term euphoria. But wouldn't it make sense that she's just doing that as a base position from which to make concessions such that some less extreme version of whatever is on the table gets done? Fool me once... Fool me two times... It feels like we are all fooling ourselves constantly and not learning from the same old tactics. No wonder Merkel says the things she says.... we actually keep listening!

As a final note, my "buy the dip in the Vixx" was looking pretty awful today though it stormed back as the vixx closed only slightly lower today. As stated in my second point, A close below 1225 tomorrow should definitely have that trade in the black.

Yes, the week really is over

Having not written since Monday, I realize that doing a recap of the whole week is impossible. Why? Because with all of the different things we hear out of Europe, it is hard to remember what happened 20 minutes ago. Wednesday afternoon around 3:30 the rumor re-emerged that the G-20 nations would be providing a 600 billion dollar bailout fund for Europe. About 20 minutes later, we learned that this was a false rumor. And you wonder why volumes are low in equities? Why would anyone try to trade a market like this when a solid fundamental thesis based on "facts" can be derailed by our trusty news anchors reporting falsehoods?

Rather than regurgitate the thousands of news headlines and try to make conclusions (I'm hearing desks with resources and personnel far more robust than me aren't trying either), I'd like to point a few things out that I've seen. First, the divergence in gold and equities for most of the beginning of the week reminded me why I didn't name this blog after an equity index. It is possible to see gold and equities trade differently. The more divergence we see the more long term bullish this should be for gold. Gold bulls are generally not those who believe that the world debt problem will finish in a soft landing. If gold remains correlated with equities, and the world debt bubble bursts painfully, then gold will go down with the equities. As we start to see divergence, we are more likely to see gold re-emerge as the safety play that it once was.

Earlier in the week (Tuesday I believe) I kept hearing about how people were liquidating gold to fund equity trades. Gold did sell off hard only to rebound back above 1750 Thursday morning (before selling off hard again). However, I'm not sure that this thesis had too much in the way of accuracy. With so many investors in cash, selling gold wouldn't be necessary to finance trades. Additionally, there was no tactical reason to go long equities/ short gold (at least none that I heard expressed). And how could there be a pairs (short one long the other) trade when they had been so correlated? I wish I could say there was more of a story to it, but for now, I'm just happy to see that the two are not trading completely in step.

Everyone was sitting on their hands waiting until today's EU summit. Perhaps unprepared for any early negative news, we learned yesterday morning that Draghi (ECB president) was (for now) not encouraging sidestepping  rules regarding money printing for the EFSF (bailout fund). I, like many, was a believer that since the ECB legally can't print money and hand it over to the bailout fund, the simple fix would be to hand the money to the IMF who would then hand it to the bailout fund. In the lawless land of Europe, it seemed to me, and apparently a few others, to be the logical 'legal' step. Draghi saying that this was not in the plans spooked the markets a bit. Gold actually got hit harder than the equities, trading from a high around 1760, gold made a low of 1707 (a nice 50 dollar plunge). Gold was trading 1727 and plunged violently to make its first low on Thursday at 1711.7 in just minutes. As has been the case for some time, the down moves in gold tend to be rapid while the up moves are more contained.

In an interview a few years back at B of A, the interviewer asked me to discuss my thoughts on the market/ trade ideas. Without much thought, I responded that I would buy volatility on any major dip. The thesis behind the trade was simply that throughout the financial crisis, we saw that volatility always spiked after a lull. In a headline driven market, one stimulus package or sign of unity among congressmen could put the markets at ease temporarily. But we were always one headline away from panic and massive influx among traders looking to protect themselves with options. As such, We're at a point where the S&P has failed to break the 200 Day Moving Average at 1264. Until we go above, it is safe to be short (a tight stop considering we're settling about 10 handles away). Vol will get bid if the trend of the market is down. For now, we're happy with Europe; trust me, soon we'll be panicked again. And then we'll be calm when they pacify us, before the pattern repeats itself like it has for months already. Buy the dips in volatility. It simply takes too little in this environment to trigger panic to not be long S&P puts.

What is the role of a rating's agency?

Today S&P (The ratings agency) put 15 Eurozone countries on negative credit watch. Friday, December 9th we are looking to hear what the EU summit comes up with as far as plans to fix the Eurozone. A friend of mine suggested that perhaps this was their way of putting pressure on the EU to make sure that it comes out with something concrete on Friday. While such a pro-active stance in the markets is probably not what ratings agencies are for, it seems to be the only thing that could've possibly prompted such a negative outlook. It is not as if there is new information that S&P has provided that changes the picture in Europe. Nothing is any different today than it was yesterday, so this negative outlook might as well have been made weeks ago. Without any materially new information, one has to scratch their head and wonder if there is any reason to pay any attention to the reminder of already-known information.

Unfortunately, part of the reason we have to pay attention to the news is that funds have mandates about the types of securities they can invest in according to the ratings that S&P among others put out. For instance, wealth managers might have an agreement with conservative investors that they will only invest in AAA rated securities. If a security that once had a AAA rating is downgraded, the portfolio manager may be forced to sell out. So it is a self-fulfilling prophecy. Now, while we can only hope that any PM managing a conservative portfolio has steered far clear from Euro sovereign debt (because it is not conservative regardless of rating) the fact that Rating Agencies' ratings are used as a barometer for eligible securities in a portfolio requires that we at least open our ears when they talk. The S&P dropped about 14 handles peak to trough after the news, but closed the day higher. Still, we did not manage to close above the 200 DMA on the S&P, though we did hit it intra-day.

While I tend to focus on my negativity toward Europe, it is important to note that there has been a real shift in sentiment towards the sovereign crisis. We are certainly not out of the woods, but there has been, starting late last week, a rally in the Euro sovereign bonds. I have mentioned previously that while equity markets have rallied, the Euro sovereign debt continued to drop. The debt generally tells the more important story as stocks can rise in an inflationary environment even if the economic backdrop is ugly. We have seen a rally in both bond and equity markets, indicating there is some actual positive (or better put less negative) sentiment surrounding Europe right now.

The home stretch

"There is no such thing as reality; there is only perception in trading". These words, recently said in response to my maintained bearish stand on the markets due to the unchanged nature of the Euro sovereigns, ring so true at a time like this. As mentioned in Wednesday's post, the liquidity program the central banks agreed upon does not solve the sovereign problem, it merely makes it easier for banks to stay afloat. Few would dispute that my last statement is accurate, but so what? If our perceptions are warm in feeling, and we want to buy up the market; we will. So bearish reality sustained, is this the time to buy for a quick upside profit? Let's look at a few of the things that I think play out in making that decision.

1) approximately 1250, is the number that gets the S&P to even on the year. With the Cash S&P settling below this number on Friday, we saw an inability to follow through into positive territory on the year. But O well; market sentiment has changed. Lots of bullish sentiment grew this week after a great slew of US economic numbers. So we could get a follow through on Monday, and the chase begins when we get into positive territory. The hedge funds down on the year do not want to see the S&P go positive while they're un-invested. They don't want to face potential redeemers and have to admit that they were down in a year that the benchmark was up. So if we go positive, some sidelined money could really pump things up. It would be like a short covering rally...only in the case its uninvested money that feels it can't afford to be anything but long (and probably in a levered way). This is the great bull scenario.

2) The VIX is lower. The vix, which is a short term gauge of volatility on the S&P, has remained low. Closing below 30 for multiple days, we are seeing a market that doesn't seem to be signaling that it feels the same desire for downside protection it did just last week. This great article by Daniel Putnam http://www.investorplace.com/2011/12/two-possible-signals-from-the-vix/

takes a recent look at the historical trends in the VIX and how it correlates with the market. Read the article for full understanding, but his overall point is we are reaching levels that are generally signaling a short term bear move, but if we stay below 30 on a longer term basis, it will be a signal of a rally to come.

3) In the near short term (next few days) no big news is due out of Europe. We could easily hover here for a few days until big news comes out.

How do you reason all of this and try to make a trade? The funny thing is that as I reread it, it seems that the bull case might be the better one. If you subscribe to my argument that above 1250 could mean its chase time, then the bull move will be swift and strong. I don't know what the magnitude of a move below here would be, but we can feel pretty confident that if the market goes up, it will start to accelerate in that direction. So if you had to choose, long or short right now, you might say you're 50/50 on whether we're up or down; and if so, then you should be going long, because your upside is more probably more accelerated than the down.

Still, I maintain a bearish stance on the market. For historical reasons listed in the Daniel Putnam article above, we are probably more likely to move down in the short run. We also weren't able to close above 1250, and while the Dow is above, the S&P still hasn't broken its 200 day DMA (daily moving average) to the upside (it is around 1265 as the image below shows.

(also note all the chart congestion from November around 1250... This should make for more resistance, making it tougher to rise above.

And lastly, how could I not discuss the muddling US congress and their likely stoppage of life upcoming. Sentiment which was as good as its been in a long while late this week, got a little more sour when it came to Friday afternoon. The Republicans indication that they would block bills enabling the IMF to fund Europe could slow things down and bring this little party we had for the past few days to a halt. I take it so seriously because we're coming up on an election year, and we already know how ridiculous the political posturing can get. Notwithstanding, this is more than just a political issue for politics; this one actually matters. Discussing "bailing out Europe" will be an easy brand job for the Republicans opposing giving the IMF power, helping them cater to republicans voters who hate the concept of bailouts. This issue is almost too good for the republicans to stand on, because it can lead as a conduit to discussions about all the other financial failures that have taken place under the Obama administration. Fool me once shame on you, fool me twice, shame on me. There's going to be a lull period here, and some of the jubilation may naturally cool off, or will be forced to if the republicans really go hard on this point. America contributes 17% of the money that goes to the IMF... how hard is it to say "Don't bailout foreign countries... use money for jobs here in America. "Oh I can almost see they wry smile on Boehner's face as he tears up because it just sounds so good. I'm happy to say that being short makes plenty of sense for now.

nearly 500 points for the Dow

Around 8 am, with gold near flat and silver down 50 cents (silver has been under-performing the last few days), I took my eye off for the market thinking that we were headed for a rather quiet day. then, in the background i heard "did silver just rally 50 cents?". I figured the question-asker had probably misread the board, but he hadn't. With silver trading flat and gold now up 13 dollars, it was the beginning of our first major buying day in a while. As I walked off the floor to my office I saw the headline that there was a coordinated global effort to help extend swap lines to European banks who have seen dollar liquidity dry up. In essence, the amount these struggling Euro banks would have to pay is now less to borrow dollars to help fund their operations. Naturally the markets reacted positively to such news (and continued to move higher, closing near the highs) as it helps to provide a lifeline to suffering banks. But why did it happen today?

Some rumors spread that perhaps there was a European bank that was on the brink of collapse. If such a collapse had really been imminent, shouldn't this temporary band-aid be viewed as a bad reminder of our situation? A few things to keep in mind before getting too excited.

1) This helps the banks. It doesn't help the Euro sovereign nations. They are of course connected, but countries' debt problems remain just the same.

2) Central Bankers approved this concept. Ben and the boys are probably a fair bit more well similarly aligned than say Maxine Waters (God help us all if she heads the Financial Serves Committee) and fellow congresspeople. Thus, this swift action, while encouraging, did not require legislative approval. Don't forget what happened the day America's congress convened to pass (and didn't) TARP the first time around (Dow -777).

3) As Dennis Gartman pointed out on CNBC's Fast Money, the Euro rally was not what it might have appeared. Euro/Dollar went higher, but the Euro was weaker against all other currencies.

The S&Ps rallied to nearly 1250, the level at which we would be flat on the year. I have posited before that a rally into the positive could cause a massive influx of buying by hedge funds who are down on the year looking to chase returns before redemption period comes out. It is a lot worse to say you lost money in an up year, than to say you lost money in a year in which the markets sold off. While it was overshadowed, all US data today was extremely encouraging. Still, I would like to see us hold above that level (1250 S&P) before I became convinced that this was a real bull market. If you believe like I do, that the swap arrangement was due to an impending bank collapse, then bare in mind just how quickly things can turn sour.

Dec-Feb futures spread blow out

Tomorrow is first notice day for gold december futures. For those less familiar, first notice day is when those who are long futures contract for the expiring month become eligible to take delivery. Most traders will spread out if they are long December futures, by selling the December they are long and buying some further out month. February is the new active contract, so most spreads done are Dec-Feb. Around noon today I looked at the Dec-Feb futures spread and saw that it was 4.90 bid at 5.00. This is well wider than I had ever seen, so I had to check with one of our traders to see if I was looking at the right thing. His response? "Wow, yea you are, I've never seen it this wide". An hour later, it was as wide as 6.5 (it may have gone a little wider but that is as wide as I saw). I wasn't really sure what it meant, just that the few seasoned traders who were offsite that I mentioned the spread to responded with an exclamatory "WHAT?". So what does this mean?

My friend Howie, who has been on the floor for some time gave me a pretty interesting explanation. I will do my best to paraphrase what he said.

For simplicity's sake lets take the spread at 6 dollars. That is a 2 month spread. So, if you were to extrapolate that to a year, you are paying an annual 36 dollars. Gold trades at approximately 1700 dollars currently. So take the 36 dollars you'd be paying, and divide it by 1700. You get approximately 2.1%. The U.S. ten year yields less than 2%. So, subtract out storage/insurance costs and you'd effectively be getting the same yield by selling the spread (buying December and selling February futures), and taking delivery, over only a two month period.

Howie's conclusion? There is a real drought of liquidity. Traditionally, anytime the spread got this out of whack the bank would just step in and do the trade mentioned above.... especially if you factor in where interest rates are. Why aren't they stepping in? Tough to know. Perhaps the banks are trying to keep as much cash on hand as possible given the macro backdrop. In any event, such action is peculiar, and is worth noting, and paying attention to when February futures expire in two months.

Happy Thanksgiving

I was told by my mom that she has only one request for the thanksgiving dinner table; "don't talk about Occupy Wall Street". Oh but it will be so hard. As I sat down to write, I looked up at my muted TV to see the CNBC  headline "Occupy Wall Street Protests cost cities 13 million dollars"; how ironic. I would love to say that I've matured to the point where I'll manage to withhold commenting, but if someone else initiates, I'll have no choice but to participate in the open dialogue.

The biggest news of the morning, and unquestionably the reason for the sell off today was a very pour German bond auction. While the German Bunds have been the safest in the EU, today's auction indicated the markets' sense that Germany is still an E.U. nation with a risk profile that makes petty yields unattractive to investors.Tack on to that the first Chinese PMI (industrial measure) contraction for the first time since 2009, you have a pretty ugly picture. And, JP Morgan came out saying that they are underweight the commodities space.

I can't say that the underweight from JPM doesn't make sense. If Chinese industrial growth is too slow, then it will curtail the demand for commodities. However, I cannot speak to the outlook for China, as even if I were well versed in the economy, who really knows what is real and what is government fabricated over there. The Bund auction fiasco is actually also bearish for commodities in dollar terms, because the dollar becomes even more of a safe haven play. Eur/USD had held near the 1.35 level, but as I write is trading 1.3335 (front month contract). 

One thing i have heard repeatedly over the last few days is the concern traders have about the fact that the US markets are closed tomorrow for Thanksgiving when Europe is open. It shows just how Euro-driven the world is right now when we see Americans nervous about being unable to get out of positions because "Europe is open". The Atlantic truly is starting to seem more like a small pond.

I don't think that people will have to much to fear in the way of news jolting markets tomorrow. We have sold off a great deal since I began getting bearish in my last two posts. I continue to think negatively, as I believe that encouraging political action will only take place following enough pain to force politicians' hands. As such, we dip before we rise. However, This move has gotten about 60 points down on the S&P from the 1225 level (where I started getting bearish). markets are currently off their lows, and Friday will likely be a low volume day. Of course, you never want to be short a quiet market. The greatest reason I am not panicked about tomorrow is just how much bad news came out today. The market absorbed the bad headlines rather well today, and more headlines such as bad German auctions and poor industrial production in China, will be tough to top.

A Happy Thanksgiving to you and yours

Ben

Just ask Alexis de Tocqueville

Today was special in that it appears American, not European news may have had a strong hand in the day's sell off. America's "super-committee", a bipartisan group of congressmen and women charged with coming up with a way to reduce 1.5 trillion of our deficit in a decade, has made it clear we'll just have to wait. The following statement was released today by members of the committee.

"We have come to the conclusion today that it will not be possible to make any bipartisan agreement available to the public before the committee's deadline" 


While S&P has since said that it won't view this inaction as cause for another rating downgrade of the United States, the fear was certainly there in the markets. This should really not surprise us of course. Even the most super-duper of our pathetic congress will not negotiate and make concessions, because it is indeed their political careers that matters most to them. In an election year, it is best to find ways to blame the other side for their role in making no progress, and use it to establish campaign platforms. I just finished watching an Obama press conference, and true to form, he did just that.


Alexis de Tocqueville, the 19th Century French writer who wrote about American democracy would likely have a few comments to make about this congressional situation were he to be around today. While he has been dead for over 150 years, some of his comments about American politics (and bare in mind Tocqueville was a great admirer of America) seem like they could be made today. 





Here are a few quotes I found from goodreads.com, that I find enjoyable:
______________________________________________________________________
"I do not know if the people of the United States would vote for
superior men if they ran for office, but there can be no doubt that
such men do not run."


“There are many men of principle in both parties in America, but there is no party of principle.” 


“The American Republic will endure until the day Congress discovers that it can bribe the public with the public's money.” 
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I have chosen to write about this today for a few reasons. First, I find it fascinating that through all the time and progression of our country, such comments could still be so relevant. Tocqueville wrote when slavery was still legal in the U.S., just to give a sense of how young of a nation the U.S. was when he wrote. Secondly, I find the fact that his quotes are so pertinent to be an indication of how hard it will be for us to break our habits. We would all love to believe that our congress will find ways to make cuts, and that we will find a way out of all of the challenges we face. And one day we will, but it won't come without the proper amount of pain that causes us to break the ways that have gotten us to this point. Our deficit issues are borne largely out of the relationship self interested voters and self interested politicians have for short term gratification. As bills come due, eventually the pain of reality will set in. If Alexis de Tocqueville could make observations about our government that ring so true today, I think it is fair to say that old habits won't be dying easy. 


When I wrote my last post, I said that we would likely see a near term sell off because of Fitch's negative commentary on Eurozone debt. We have sold off, and now, near 1185  on the S&P sit in the middle of the range high to low from the years highs to lows. Short term bounce? Perhaps, perhaps not. But the outlook has to remain negative because of what we are seeing in governments across the globe. There is an inability to act in concert to try to take on the problems of the world. The failed experiment that is the European Union of course suffers from individual nations' economic/cultural interests differing while sharing a single currency that cannot be all things to all participants. America has no such issue (there are differences between states, but they are not nearly the differences Eurozone countries have) and still it seems cannot act swiftly to help stem the crisis before us. Like in 2008, we will find that until we are pushed to the brink and forced (a Lehman like event, even if it takes on a different form) to deal with our debt woes, we will go on voting in the same duds we call our leaders, and they will continue to make unrealistic and unrealizable promises. 


Does it strike you as funny that on a day like this where the US news is so negative that investors flee to buying US treasuries? If that isn't an indication of  how cockamamie things are I am not sure what is. But this is not an indication of market insanity, or irrationality. Comparably, U.S. treasuries probably do deserve to be a safe haven. It is rather a reminder of how dire our situation is, and that soon, barring a miracle, there will not be any place to hide. The founding fathers, contrary to widespread public thinking, purposely chose to create the system of American government to make progress hard to come by. This, understandably, was the safeguard against tyranny. Now however, we are in a tough spot, because we need more progress from our government, but history tells us that the pain will come before the jubilation.


The counter-argument to this pain before gain scenario I have laid out is that of stimulus. What if tomorrow the US and Europe came out with stimulus plans to boost all economies. Even if they were to be unsustainable, the markets, particularly the equity markets should have a field day. That is the risk of being in cash (and hence missing the move up). As the New York Lotto slogan used to go; "Hey, you never know". But bear in mind, that with national debt reduction requirements looming and the inability to reinvigorate the economy through lowering interest rates (we're past that) the number of tools that we have for stimulus are ever-more limited. What policy-maker, no matter how short sighted would use up the tools they have at their disposal now and not save them for a slightly rainier day? Perhaps Tim Geithner, but thankfully, no one listens to him anyway.


I am more than happy to miss an end of year rally of 10% to the upside to protect what money i have as all of the charts begin to break down. Lots can change, and perhaps with the prospect of sideline money coming to the table come January 1st will derail this thesis assuming we are able to coast for a while. For now however, it is far more prudent to stay short, or just out. As for gold? Everything I can see going on as far as money printing in Europe should be bullish for gold. If the dollar continues to be a safe-haven however, its purchasing power makes gold less attractive. I think the time will come when gold makes new highs into the 2000s and perhaps beyond. For now however, it is far too correlated with the stock market, and I would not become bullish unless my outlook for stocks is wrong, or we begin to see divergence between the way gold and stocks trade.

Abercrombie and ......

That ugly beast above is the ANF (Abercrombie & Fitch) 10 day chart. Charts like this remind me why i try not to waste brain matter while "experts" make investment recommendations on retailers. Predicting retail sales and consumer trends is no easy business, and this type of chart makes me wonder why I would ever participate in such a hard to predict area when this kind of risk is on the table. I would rather try to focus on what I can know, and how best to put that knowledge to use. For instance, if new information on sovereign debt were to come to light from say, a rating agency, that might pique my interest. Fitch, the rating agency, not the retailer (though I am about as interested in what they have to say as I am in wearing A&F's clothes) can take credit for today's late day sell off. So why doesn't this get me intellectually curious to hear what they have to say? Because they are not saying anything new. 

"Fitch's current outlook for the industry is stable, reflecting improved fundamentals at most banks combined with ratings lower than at pre-crisis levels. However, risks of a negative shock are rising and could alter this outlook," 

This causes the market to sell off?! Anyone with a 56k dial-up modem and a morsel of interest knows that the bond yields have done nothing but blow out. Italy 10 year over 7%, and the other peripherals spreads all widening is not news. I even commented to a friend this morning about how well the market seemed to be holding up given the news that was out. The morning note he had sent me had bullet points showing that Unicredit, the Italian bank was looking for ECB funding, followed by talks of growth concerns in Japan, and and the potential inability of Chinese developers to pay off loan interest. While we were lower, given what looked like important NEW news, I thought we held in pretty well. Then all of a sudden Fitch (where were the rating agencies pre- last financial crisis by the way?) warns of contagion if the Eurozone does not get its act together soon. I have to wonder if I started a rating agency, and came out with a statement on how cheaper labor in underdeveloped nations poses a risk to job growth in the United States, if the market would react the same way.

All negativity aside for a moment, it is hard not to pay attention to this news. Not because it is news, because, I repeat, it assuredly it is not. Rather, for some reason the markets seem to care. Maybe it was a convenient excuse to try to stop out some longs; but either way, the market cared.  After the US rating was downgraded in August, what happened? We tanked (see August 5th graph), and there was nothing that was news then. It was simply a reiteration of known information by the big bad rating agencies. If human psychology hasn't changed, I see no reason to think this time should be any different. A nice short term dip is likely in the cards.

yaaaaaaaawn

Today would've been a nice day to just not bother opening the markets. There is absolutely no volume, and no news to speak of on this late fall Monday. Over the weekend, Silvio Berlusconi resigned as Italy's Prime Minister, and Mario Monti has been nominated to replace him. Monti is an economist by trade, who serves in the Italian senate. Greece's new PM is Lucas Papademos, whose background at the ECB also makes him a more finance savvy leader than his country had previously. While we go nuts over every headline, this should bring some, however minimal, comfort to the world. At least these countries are putting people in positions of power who have a clue as to how this whole economics thing works. While there will be no pretty way to work through the European debt woes, it is better to have people who realize what is at stake, how we may have gotten here, and perhaps even some ideas of how best to get out. It may seem pathetic, but in a world of economically clueless career politicians (thank you John Huntsman for addressing the Italian debt issue by discussing how bond prices move inversely to yields), it is nice to see some relatively capable minds at the helm.

Former convicted lobbyist Jack Abramoff has been back and about and recently did an interview with CNBC. He has a a new book that he is promoting, and as such a few grains of salt are probably necessary when digesting his words. Nonetheless, in the interview Abramoff discussed how it is perfectly legal for senators to trade stocks based on the closed door political information they have. It is not insider trading in the way we might think, because such knowledge is not privileged knowledge about a public corporation. In other words, there is a difference between knowing Google's earnings, and knowing that there might be an economically stimulative plan forthcoming. Take a moment to think about which information is actually more important in today's market. Of course good earnings drive the market, but stimulative politics could mean even more. We have seen the effect that economic stimulus has on the markets, and to know such information in advance would be an enormous advantage (hard to see how you could lose if you just put on short duration trades). Perhaps there is a hidden positive in all this. If doing something in congress enables congressmen to trade... then maybe it will actually give them an incentive to do something.... but I won't hold my breath.

I'll cut 3 government agencies....

As I sat at dinner with my dad last night I was disappointed to realize that I had forgotten to record the republican debate on CNBC. I understand that it might seem nerdy to be so entertained by these debates, but honestly, after what happened last night how can you not. I came back to see the already famous Rick Perry blemish where he vowed to eliminate 3 government agencies.... but could only remember two. O well, 66% is passing on most grade scales I am familiar with.

The first instinct we likely all have is "Perry is done"; its over. It seems hard for me to keep a straight face and say otherwise. But let us not forget, that there was a Texas politician who spent 8 years in the White house, with multiple blunders that can compete with the Perry brain freeze. "The legislature's job is to write law. It is the executive branch's job to interpret law". This George W. Bush comment in 2000 puts more doubt in one's mind  about his ability to pass government 101 than Perry's blunder might. Perry is not as affable as Bush, and doesn't have the political minds around him or family history that Bush did. Still, to say "he's done" given just how many painful forehead slapping moments we went through with Bush, might be premature.

I made my short term bearish call on gold 2 days ago when we were trading around 1790. As I write, we are 35 dollars lower, and made a low about 20 dollars lower than that during today's session. My technical expert friend told me this afternoon that we needed to hold above 1761 to see upside. Having climbed rather impressively from 1737 to 1763 during the session, we ended up settling 1759.6; right near his number. While letting your shorts run has been successful for the last few days, I would want to cover any shorts going into tomorrow's trading session. It is not that I think we are going higher. In fact I think we probably have some more room to the downside. But I have found that trying to trade on Fridays with expectation of similar market moves from the week is a solid losing formula. Volume tends to be lighter, and it is too easy to get stopped out in what generally becomes a rather range bound market. Flatten out, see how the day plays out, and see what the market tells you as the day goes on.

In a brief moment of speculation, I have to think that some rather large player may have been liquidating the last few days. The post settlement 20 dollar drop from two days ago still does not seem to have any fundamental basis. In today's action, we saw gold collapse violently to the downside, dropping over 50 dollars peak to trough on a day where the equity markets held in positive territory. Lessons to be taken? Whether or not it makes sense, moves like the 20 dollar drop the other day in an otherwise quiet environment have to serve as warning signals. Trying to "be right" about the market is a losing concept in such scenarios. Also, the fact that puts were catching a bid as gold approached new medium term highs (puts were catching a better bid than calls as we approached 1800 for the first time in 2 months) was a tip that it was better to place bets to the downside.

Perhaps a quick breather for the Gold Bull

During yesterday's session gold behaved pretty normally given market conditions. On Monday, in typical gold fashion, December (front month) futures made a high of 1799.9. Yesterday (Tuesday) it made a high of 1799.8, only to retrace before eventually breaking through 1800. What was interesting was the end of day action. Volume had been light the whole day, and as settlements came out around 1:45 pm just below 1800 gold started to come off. It has not been uncharacteristic for gold to make moves higher or lower after settlements come out, but at its trough (post settle) gold made a new low on the day near 1779... a near 20 dollar drop. For the kind of volume that had traded, and the relatively contained intraday moves, this was quite surprising to me. It is true that the low volume while reaching a high  that we experienced today (we are at the highs since September in gold) is reminiscent of the volume we saw when gold made all time highs before falling off a cliff. This is worth bearing in mind, though I do think it is worth considering that the equity market volume has also been very light as of the last two days. The low volume across markets makes me take the light volume we saw in gold at the top with a grain of salt, when otherwise it might set off sell warning signals.

Still I cannot say that my short term outlook for gold has not turned more bearish. In the middle of the day I was thinking to myself about all of the people who become wrapped up in "what the market is supposed to do" and how their steadfast feelings can only be hurtful at times like this. Then, I caught myself saying the same things post settlement. I called friends seeing if there was any news out that I was unaware of. At the time, it looked like Berlusconi was going to be resigning... I couldn't really see how this would be so bearish for gold. The Euro rallied on that news, meaning weaker dollar, so unlikely that should cause a sell off at all, let alone a 20 dollar sell off. Then I learned that the Chinese 2 and 10 year bond yields had become inverted (generally indicates possible recession ahead). So I thought I had found my reason. But it turns out copper, which has its price tied more to the Chinese economy than either gold or silver was not making new lows as gold was. And the equity markets? They were making new highs on the day. 

Today was one of those days where I just have to admit I have not the slightest clue as to what caused this divergence, as very little that I can see in the news or trading action can help me explain it. As such, while I think that the Euro situation is very bullish for gold, I cannot help but take this afternoons price action as a short term bearish signal for gold. As successful traders have often told me, you have to look at what the market is telling you. This is a short term move at this point, and as such it is a short term call. And while the bull in me would love to buy the dip and say it is unwarranted, prudence tells me it is better to be flat to short this market.

Its the bonds stupid.....

Amid the volatile equities markets, and all of the hoopla surrounding whether or not "this time is the real one", it is easy to forget the indicators that stare us right in the face. As Europe's demise has been the main focus of the market's attention, many of us (including hedge funds of late I'm told) have decided to stand on the sideline while allowing the others (and algorithms of course) to wage battle on each other. For those who are not hiding money under the mattress (which I'm convinced yields more than the 6 month CD I have), you might look at the macro picture, and see where equities fit in. A reasonable first question to ask is "do I think things are getting better?". "Yes" would seem to say that being long equities makes sense, and "no" or "I have no clue" would seem to suggest  staying away. But for now, the market is telling us the answer is no. All you have to do is look at the sovereign debt spreads in Europe. Through the recent rallies and occasional encouraging news, the bonds in these countries have seen waning demand. In my simple mind, I am willing to accept this as all the information I need to have for the time being that the economic situation in Europe is still incredibly dire.

So how is it that equities can perform in such an environment? Inflation, inflation, inflation. It is true that big Ben Bernanke has continued to say that inflation targets are met, and that prices are not spiraling out of control. There is room for debate about that, but it is rather clear that the policy options of intervening governments leave the door open for inflation. In the US rumors continue to swirl about a potential QE 3. Even if not, zero interest rates are unquestionably here to stay. In Europe, while the EFSF is not supposed to be taking ECB printed funds, Euros are still likely to be printed. And, today we learned that China is injecting 1 trillion RMB into its banks. More liquidity is stimulative and leads to inflation. While China has made moves to keep interest rates high to keep its hot economy in check, injecting liquidity into the banks can be nothing but inflationary. Bottom line, equities benefit from an inflationary environment as bonds suffer decreased real interest rates (the interest you receive in inflation adjusted terms).

Thus it is important to remember to keep an eye on the bond markets, and not assume that rallies in equities are indicative of confidence in the ability of struggling countries to combat their debt woes. If that were truly the belief, you'd see the bonds rally. Of course gold also benefits from inflation, but it is more likely than equities to get a "safety" bid, if panic sets in. As such, while playing the stock market from the long side is one way to take advantage of the likely inflationary environment to come, gold's added safety clause makes it even more attractive.

Everyone Forget the Silly Fiction (EFSF)

It was on October 14th in "Timmy Talks" that I wrote the following.

While Europe has bought itself time, and continues to give more promises of grand plans for which there is no evidence, Geithner provided no reasons to make an onlooker believe that such a plan really exists. Rather, he seemed to indicate how undefined the plan is as it currently stands. Even if we don't have influence over the IMF that we fund, it would seem reasonable to me that the secretary of the treasury might have some concept of what is going on there. Perhaps others feel as uncomfortable as I do when watching Geithner, which makes me wonder if everyone completely missed how disconcerting that interview was. 


On that day, I decided to listen to Tim Geithner's monotonous answers, in hopes to find clues about the future in Europe. Today, it seems that that whole interview was nonsense. This morning, Angela Merkel stated that at the G-20 was unable to come to any understanding as to how the IMF would be used to fund the EFSF. Of course this has a tint of political posturing, but think about what this means. As previously mentioned, under German law, the EFSF cannot be funded by ECB money printing. That leaves the IMF, the private sector and China to help. China isn't rushing to help... why would they? If i were China I'd rather wait until desperation time when they will get more in return for providing funding...China isn't out there to make friends. O wait... Euro countries could pool their own money for the bailout...ha! If we don't see any progress on the IMF front, then we may have to see the situation become far more dire before we see any other potential financiers of the EFSF step in.

Enjoy the weekend,

Ben

Q.E.stions for Big Ben

The main news on the docket today was an earlier than usual FOMC (Federal Open Market Committee) meeting ahead of a Ben Bernanke speaking appearance. The first headline as always is the what the Fed decides to do with interest rates.... and as usual the answer is nothing; they will keep them near zero. But the Fed announcements still hold meaning, as the language used in the release is scrutinized in search of any indication of future Fed policy decisions. One of the key things investors look for is any sort of tip off on whether or not the Fed intends to do quantitative easing. Quantitative easing(QE) is when the Fed goes out and buys up U.S. treasuries (longer dated, which in turn makes their yields lower). With lower rates, theoretically, it becomes cheaper to finance various purchasing/business activities, thus making Q.E. stimulative for the economy. The purchasing of these securities requires money printing, which is potentially inflationary.

There was no explicit mention that QE would be used, but 'mid 2013' was explicitly used as the earliest time the Fed could see an interest rate environment not marked by extremely low rates (ie they're not raising rates for a long time). A low interest rate environment forces people to put money into riskier assets to get a return, which is stimulative. The real world sad implication of this is that grandma, who retired with enough money to rely on a fixed income, is now forced to take riskier bets to get the same returns she would've pre-near zero interest rates. The Fed continued to remain tempered on their description of the economy's progress, which some view as an indication that they have not taken using QE as a tool off the table. Also, for the first time, a Fed governor dissented with the Fed decision from the Dovish side (saying that the Fed should be more accommodating in its monetary policy). In the past there have been dissents saying that the Fed needed to raise interest rates, but this dovish dissent is an encouraging sign that QE may still be used in the case of a stalling economy.

The Fed reiterated its commitment to reinvest the interest from the asset backed securities it holds. In the Q&A Big Ben stated that inevitably the goal is to have the fed balance sheet with treasury securities only (not asset backed securities). Currently however the Fed invests in these asset backed securities (more specifically mortgage backed securities) because it helps aid the struggling housing market. The focus on the housing market makes sense, because it is the driver of so many jobs. Think about all of the jobs created from home building. Building a house requires material companies to obtain the necessary materials, construction workers to build, architects to design, interior designers to design, banks to provide financing, and inevitably  workers to help with the upkeep (I'm sure I'm missing plenty of other jobs). The problem is that the housing market was a bubble. Is it prudent to try to "restore" the housing market, when you would simply be restoring a bubble? We are trying to grow our way out of the situation, and hence it is necessary to have the job- producing housing market healthy. At the same time, it is critical to realize the catch 22 that we face with respect to balancing overextending the housing market, and keeping it churning to boost employment. Tough job Mr. Bernanke, I certainly don't envy the task in front of you.

Europe:

Yesterday, the Greek Prime Minister reneged on his parliament's vote for an austerity package that would appease and guarantee temporary funding from the EU.  Stating that the vote would be put to a public referendum (let the people decide). I had suggested that the only explanation I could think of, was that he was using this as a temporary appeasement to the Greek people so that they would not squash him in this Friday's vote of confidence. Since the referendum wouldn't be for months, he could gain the vote of confidence, and then renege on his people the same way he did on the EU. But Ah! The EU did something intelligent! Dow Jones just reported that the EU told Greece that they would not receive any funding until the referendum vote took place. So, if my suggestion was indeed the prime minister's intent, he will now have to win confidence without money guaranteed....no easy task. I won't even venture a guess on how or when this will come to a head, but it is an extremely critical point, and one that I think is not being talked about nearly enough (today at least). If Greece were to overturn its parliament-passed (easily passed by the way) austerity package, then default would be back on the table. Were that to be the case, mama Merkel's crafty move to ensure the Greek Credit Default Swaps weren't triggered would be in jeopardy. That scenario would be nothing short of explosive.

The MF'ing global scenario

As I walked on to the floor of the COMEX this morning I saw a table with two exchange employees with a list. I asked what they were doing. It turns out they were checking if members cleared exclusively with MF Global, and if they did, then they would be denied entry to the floor. As I rode the elevator back to write this piece on trader got on, clearly a bit frazzled and unable to remember what floor he was going to. after two guys who knew him chided him a bit, he took a deep breath out saying "long day for me boys". "I can only imagine" one of the two responded. The frazzled trader then glibly said "I wish you could".

I doubt too many people sit around feeling bad for commodity traders, but take a moment if you will to consider what a small independent trader is experiencing as a result of this whole situation. First, for those unaware, here are the basics of the MF Global situation. 

Last week they reported dismal earnings, which started to raise questions about the bets they had on. It turns out that MF made big bets gone bad in Europe, so much so that it caused them to file for Chapter 11 bankruptcy. MF Global's CEO is Jon Corzine, former head of Goldman Sachs, as well as, more recently, former governor of New Jersey. Following the bankruptcy filing, the CME group (the exchange) said that it no longer recognized MF Global as a guarantor for traders on the floor who used them as their clearing firm. Clearing firms extend leverage to their customers, and are responsible for monitoring the risk within customer accounts to ensure that customers have enough margin (cash collateral effectively) to satisfy the risk in their accounts.

Set aside the notion that every trader drives an expensive sports car and has a vacation home in the Hamptons. Many traders on the floor come to work every day trying to grind out a living; a highly stressful one at that. Those who clear with MF global are sitting somewhere, watching their position move, with no ability to take off risk. Their accounts are frozen. When dealing with commodities and options on those commodities, moves can be swift and unforgiving. A trader's career can literally be made and broken in a day.  In volatile markets like these, it is hard to feel anything but sympathy for the traders unable to manage their own risk at a time like this. Moving a position/ receiving approval at a clearing

Currently, the MF Global books are missing something like 700 million dollars. MF Global (literally as I write) has admitted  to using client money to help fund the trades that they were doing principally (using company money to put on trades). These funds are of course supposed to be segregated, and commingling client money to fund principle trades is among the most egregious crimes that such a company could commit. Bear in mind that whatever the "missing money" number is cannot account for the un-quantifiable amounts lost because traders could not hedge gamma/ take off risk while their accounts were frozen.

As if this is not enough, what are the greater implications of this MF'in situation? I just woke up from trying to read through a document on the implementation of the Volcker Rule. Apparently, on October 11th, The Fed and FDIC approved it. We are entering a world of law implementation that I am quite unfamiliar with at this point (I didn't know the Fed would have to approve anything as an independent agency). Anyone who can comment, please do. But to make the simple point, the Volcker rule restricts the ability of commercial banks to trade their own books. MF was not a commercial bank, so it would not have applied to them. But let's not be so caught up in technicalities as to dismiss the ammo the MF situation has given to Volcker Rule proponents. While I know the shedding of prop desks began years ago and hence there is a discount already built in, be wary that talk of curtailing a bank's ability to take on proprietary risk can only be bad for their stock prices.

http://www.gibsondunn.com/publications/Pages/VolckerRuleProposalHighlights.aspx

We're Saved! Greek haircuts and market bliss

Below is this morning's Wall Street Journal front cover picture, The Italian Parliament going at it



Could you imagine if Orrin Hatch went after Chuck Schumer following a nice fiscal policy debate? Or perhaps John Kerry (good reach) taking a swing at john Boehner? Unquestionably there would be tears streaming. Sadly, our do nothing congress just isn't this entertaining. But who can really complain when all of our problems are solved?

Overnight a deal was done that puts a 50% haircut on Greek bonds. Without too much detail, this means that Greece will not pay all of their debt obligations, rather a portion thereof. This helped to send the markets into a state of euphoria as it was a sign of progress in Europe. The jubilation and soaring stocks (Germany up 5+ %, the Dow up nearly 400) are indicative of something I've discussed before; that it does not take much positive news out of Europe for us to rally like no tomorrow. Whatever your opinion of the news we rallied on, the chart and momentum has changed significantly as a result of it. Closing circa 1284, the S&P is now comfortably above the 1250 level considered to be the top of our "range'. In what has been a volume anemic market we started to see some real volume trade today (moves on heavy volume are more meaningful than light). To top it off, there are a lot of wounded hedge funds who are staring at a year of negative returns in which the stock market went positive.....eeek... here come the redemptions.... well... maybe not if we ratchet up some risk! But you want to short a market that rallies like this on news that doesn't even begin to address the real problems (Italy..Spain...)? Like I said when we were trading 1220 at the "top" of that range, your better off being long. So lever up and try to ride a wave up in hopes that you can save your precious hedge fund. Flows will start coming back to the equity markets (bonds got destroyed today) and we should push higher.

I had to mute the TV when I heard some analyst talk about how "I wouldn't enter now, I think we're going up, but there are better entry points". Come on, make a call. This is like when CEOs are "cautiously optimistic". What is that entry point? Support at 1250? So you think its worth waiting to get 30 points, and risk losing upside of 70 with this kind of momentum? And if support at 1250 doesn't hold, how can you justify buying then? Effectively, this double speak is nothing more than that. It is a recommendation to try to make the "perfect" easy stop out trade, and miss what could be setting up for a runaway rally. Buy here, don't wait. Stop yourself out below 1250, take your 3% or so loss if we fail, and call it a day. This seems far less risky than "waiting for a better entry point".

Talking to someone whose opinion I greatly respect a few minutes ago, it was mentioned that there's a lot of quiet negative talk out there, and we'll probably give back a portion of today's gains. Perhaps we will, but the hedge fund catch up scenario seems too powerful to me to wait. I am in no way positive on Europe. In fact, I think what happened today was nothing but a PR stunt. But you have to ask yourself if you put on trades because you believe in the fundamentals behind them, or because you believe they will work. I don't believe Europe did anything today, but I do believe the markets are going higher... so I'd rather my money be right than me.

Here is why I don't think anything was actually done today, and why it sets us up for a disaster scenario somewhere not too far down the road. The biggest concern in Europe is not whether Greece, or even some of these other countries can pay their debts. At least in the case of Greece, everyone knew that they could not. The issue is what happens to the banks who hold Greek assets. If you are a holder of Greek bonds and they default, what does it do to your balance sheet? MF Global is a sub 2 dollar stock for this very reason (more Italian debt, but Euro debt exposure more generally). So Greece didn't "default", their bonds just got nicely trimmed. For some reason I'm not nearly bored enough to examine now, this is technically not a default. This might not really matter to an outright bondholder. If your getting 50 cents on a dollar, 50 cents is 50 cents, it doesn't really matter if you call it a default or not. But then, there is a little something called CDS (Credit Default Swap). Why they haven't been made illegal yet is beyond me, but here is what is at stake.

CDS is essentially insurance on a bond. If I want to buy a bond because I think it is of good value, but want to protect against default, I can buy CDS on it. CDS is a separately traded contract all together. So buying such insurance is not an embedded option you get when buying a bond. So people who go short CDS (serve as insurance writers, betting that a bond will not default) likely don't have nearly sufficient enough collateral to make payments in the event of a default (if the letters AIG are coming to mind your not crazy). The famous "Greek Haircut" was done in such a way that those who are long CDS (bought insurance) will not get paid (consequently those who were short it, and likely massively leveraged in their short do not have to pay). I don't know what is on which bank's books, but I would lever up myself to bet that a significant amount of exposure that these banks have to Greece is in the form of Credit Default Swaps. But, because of technicality XYZ, the haircut doesn't trigger this CDS insurance, and the insurer, who is screwed won't have to pay. So there is progress in Greece, and the banks maintain their solvency. Pretty cool.

But somewhere, there is a team of investors who went super long Greek CDS preparing to make an entirely new type of investment... a massive lawsuit. There are one of two simple things that will come from this. Either there is some sort of resolution in which the CDS holders get paid, or no one will ever trade CDS again (barring an explicit change in rules). Greece has defaulted, and holders of that default insurance are not getting paid. If the lawsuit were to be successful, what would happen to the liquidity of these French banks with such massive liabilities? The speed at which such a liquidity crisis contagion could spread is nightmarish.

But for now, we're running hot. I'd rather jump on the bandwagon even if I didn't have any skin in the game. With a break in headline risk (unless this lawsuit comes forth soon) perhaps we can focus on the fact that q3 GDP for the US came out at 2.5% today, certainly not indicative of the recession the market had been pricing in.

Sell Euro stocks with exposure to the tabloids....

No no, I've got nothing about Rupert Murdoch. But without Silvio Burlusconi at Italy's helm, the page 6 reporters will have some serious writers block. The womanizing Italian Prime Minister is rumored by some Italian news sources to have agreed to step down from his post in the next few months. While his talk in Brussels of selling off Italian government owned assets to raise funds might have seemed amenable to some, the mere fact that Italy would openly state their intention to pathetically raise the retirement age by two years IN 15 YEARS, might just reinvigorate some skepticism. The German parliament, in a runaway vote, gave Merkel the power to negotiate an expansion of the EFSF (European Financial Stability Fund). But this German approval for Europe's most powerful leader states that the EFSF cannot be financed through the European Central bank. Also today, Mario Draghi, the incoming president of the ECB (starting November 1) put his support behind buying the debt of European nations. So what's the takeaway? It would seem to me that without the ECB to print money, the EFSF will not use buying sovereign debt as a tool to bailout Europe. 

Without funding from the ECB, the EFSF will either become obsolete, or have to find other means of funding. Enter the IMF. The IMF, as previously discussed, can receive funding from international bodies, including the USA. Then consider that the EFSF head Klaus Reglis (I'm learning more names by the day) is courting China to contribute to the fund (EFSF). China is under-represented in the IMF, and by contributing to the EFSF through the IMF, it might be able to gain influence. China would hold the most leverage in gaining such influence in dyer times, so I would not expect them to make any commitments anytime soon. But if things start to turn bad (ha... turn bad) in Europe, then China might just start to enter the equation a little bit more.

Today was November gold options expiration. Gold settled at 1723.5 having stayed positive all day while the stock market bounced around and went negative before closing higher. Keep your eye out for GDP numbers, coming out at 8:30 am tomorrow.

Wait... Europe Doesn't have a comprehensive plan? welcome back Gold

Europe reminds me a little bit of a group of my friends and I when we took a high school class entitled "short stories". None of us ever did the reading, and before class, we would all scramble to ask those who did to give us summary points so that we could pretend to have any clue what was going on. This worked out great, until one day, one of the "readers" decided to tell one of us some false information about the previous night's reading. When asked how a woman in the story had died, my friend, aloud in front of the class exclaimed "She was crossing the street at night and a car without its lights on struck and killed her"... Suddenly laughter and shock erupted from those who had done the reading... and the rest of us quickly figured out what happened. Turns out she had died from pneumonia.... O high school stories.

So Europe has been scrambling to come up with some semblance of a plan, and it becomes clear that they don't have one. The market came off big on the open, but perhaps it was because some interpreted that the entire summit due for tomorrow was canceled. It wasn't, rather they canceled a finance minister's meeting, which does not hold the same magnitude. The market recovered, but down 25, we closed at the lows of the day on the S&P. This market doesn't have faith in a comprehensive plan come tomorrow, as it should not. But now it is time to shut out the panic filled media and think about how we can capitalize on what looks to me to be a great opportunity... particularly for gold... and soon for equities as well.

A few posts back (Risk Off time, Oct 17) I pondered what it would take to see the strong directional correlation we had seen today between gold and the stock market break. I mentioned how we saw a few signs that it was breaking a bit, but that the options and often the underlyings (stocks/gold futures) were generally trading the same. But that all broke this morning. As the S&Ps fell, gold dropped all of 5 dollars from 1655 to 1650, which it held before rising 50 bucks to settle at 1700.4. As stocks sold off, the volatility rose as it usually does when the market is down. The Vix (front month volatility) rose back above 30... in fact yesterday was the only day in October it had been below. Gold volatility also rose, but as mentioned, gold was up. Call options picked up a strong bid after being picked on for the last couple of weeks. During gold's rise to it's highs circa 1930 (the dollar amount) the pattern was that as gold rose, so did volatility and call buying. 1 day does not a move make, but we saw that relationship that the gold bulls have missed so much today.

Last week, gold rallied and failed around 1685 on four separate occasions, but today gold had no problem climbing above it. I am told that 1696 is an important level as well. A floor trader pointed out that not only did it break, 1696, but that it did not break below it once it broke above (bullish sign). The high in gold (I'm not sure of the exact figure) was approximately 1925. The low on the down-move we experienced (which happened overnight as so many of our critical moves have) was 1530. So in order for us to retrace 50% from High to low, we are looking to test somewhere in the 1725-1730 range. From there I expect we hold and make our way higher as gold reestablishes itself as the safe haven from world events. 

Before the naysayers get too jumpy, let me just say that the idea that a 50 dollar move today means you missed the move would simply mean you haven't watched gold over the past few months. Two times I have had to bat my eyes twice as I watched gold drop $100+ in a day in these past months. While our moves have been contained of late, a $50 move (or about 3%) is not so significant at a time where European deadlines are likely to contribute to persistent volatility. The move this morning in gold came on fear of absence of a plan... so gold was the fear play. If that is back, what is the contrary scenario? Europe comes up with a comprehensive plan. But what plan doesn't involve the printing of money?

If fiat currencies are going to be devalued, this is a big positive for gold. This bullish gold scenario has played out after we did quantitative easing, and it will happen again if Europe starts printing.

One of the risks to buying gold is that a Euro disaster, or comprehensive Euro solution should they print should lead to devaluing of the Euro. As such, many (as Denis Gartman has often advised) have suggested buying gold in Euro terms as opposed to dollar (sell Euros to fund buying gold so as to gain in both Euro devaluation and gold appreciation). This makes sense, as we have already seen the willingness of traders to use US treasuries as a safety haven. Whether that scenario will replay itself in the event of a Euro meltdown I can't know, but it definitely supports the case for buying gold in Euro terms.

Lastly, I will point out the nearly forgotten number of the day which in a general market would be the top headline. Consumer expectations as measured by the consumer confidence poll was the lowest it has been since March 2009. The fatalist gets scared and discusses how consumption makes up something like 70% of GDP, and that such a number means we're going down. I say, March 2009 was the low of the entire financial disaster move down... so a reading at such a level is more likely bullish as overdone than it is bearish. That being said, if you haven't put on any equity positions I think the risk/reward is rather iffy for doing it overnight. I would rather put my money in gold and risk missing any short term (ie tomorrow when we were scheduled to get this Euro announcement) pop in equities... 

Also, I try to avoid conspiracy theories, but I couldn't help but notice that the "Euro meeting isn't happening (finance ministers as it turns out)" story came out practically on the open for U.S. stocks. While my confidence in Euro leaders is small, I do trust that they were aware that stocks in America opened at this time, and that the open can set the tone for the day. Perhaps they wanted an indication of how market sentiment would handle such news... sick joke... or maybe it just happened to be coincidence. I'll avoid taking any guesses, but it is worth storing this little tidbit somewhere in the back of our minds for a rainy day.

Lessons from the Subway

I was on the subway this evening, and on stumbled a man with a cane, a bag for food, and plastic container held together by a string for any monetary donations he might collect. Appearing to be vision impaired, he began his routine by showing one of his eyes and its redness, discussing how he had been (sorry for the imagery) "stabbed in the eye on his way home from work", and lost vision in that eye. For some other reason, he claimed poor vision in the other eye as well. I was very curious to see how the others in the car reacted, as I had a strange suspicion that his presentation was a bit too subtly refined to be completely true. His use of being stabbed "on the way back from work" painted a picture of someone who was out there trying to do the right thing (work) and just got unlucky. These are the people we want to help, the ones who are trying their best, because especially now when sentiment about our own future employment prospects is far lower, we fear that we might one day walk in their shoes. Emphasizing that he would take food, the lady to my right gave him some almonds she had, and then a dollar. Then, a 30 year old woman (give or take a few) with her boyfriend gave a bag which had some takeout that looked reasonably high end. This guy had made a pretty good splash, but the man sitting across the isle had a look of doubt. At that moment, I became pretty sure that my suspicion was right, and that these women had been duped by a pro.

After the "blind" man made his way through, the man across the way, adorned in an enormous awesome ugly patterned hat started teaching the rest of us about the act. He started explaining how a simple eye irritant could cause the redness he showed, and that were he to have been stabbed, there would need to have been some scarring around his eye, which indeed there wasn't. To add a little levity, I turned to the lady to my right and said "at least it was only almonds", not making mention of the dollar. At this point, our friend chimed in about how he used to give a dollar to a man in a wheel chair until he saw him get off one day, and throw the wheel chair over his shoulder as he trotted up the stairs. Ok, you mentioned the dollar, now this sweet woman just feels like an idiot. So much for my efforts.

Lost in my thoughts the rest of the ride, I imagined that had I had a friend with me, I would've probably bet him that this guy was an actor. Burden of proof would have been onerous, but our big hatted friend made a very strong case, broken down with solid relevant evidence. I would've made this bet at the point that I saw the look that Mr. Big hat had on his face during the ordeal. Mr Big hat looked like he had been around and probably had a little more street wherewithal than myself. So I began thinking about how sometimes the best bets we can make are not the bets we make on our knowledge, but our knowledge of those who have more knowledge than us.

So now that the S&P settled on the week above 1230, who to look to for answers? It probably makes sense to choose the smartest guys with the best track record, but as many know, that can get you in a world of hurt quickly. Anyone who tried to construct a portfolio based off of John Paulson's ideas following his subprime score is probably missing 1900/oz gold (you'll get it again soon be patient) and wondering if Meg Whitman can help those far less valuable HP shares they are holding recoup some losses. Two different market environments, two very different results. But while Paulson might have made a few bad bets on stocks, I would raise a very curious eyebrow if all a sudden he started buying subprime. Now however, subprime is not  the main driver of this market. So who would be good at dissecting a market like this? No, its not Warren Buffet, Bill Gross, or Julian Robertson. For a time like this, I wanted to hear what Bob Doll, BlackRock chief equity strategist had to say.

Why Bob Doll you ask? I had thought that Friday's S&P close above 1230 meant that we had reached a point on the chart where we could expect some buying to come in and push the market higher. As discussed in previous posts (particularly the last) I have been concerned that the headline risk game might be keeping investors away from a market that has the potential to creep higher. This "melt up" scenario happened following the lows of March 2009. While I can't speak to exactly when Doll put on his long call on, he definitely was dead on for most of the S&P's move up from 900 to 1200. After the events of our financial meltdown, people were scared to put money in markets, even as stocks started trading at silly valuations. Thus there are similarities between now and say July 2009. Investors are scared to get out of cash, and the headline risk, which could tell us at any moment that the world is doomed, controls the markets. 

So I decided to check out Doll's letter. (included below)

http://www2.blackrock.com/US/individual-investors/market-insight/investment-commentary/bob-doll-weekly-commentary

Doll, during our last "melt up" finished nearly every letter the same way, discussing how the fundamentals of earnings lent them to continue long exposure to equities....all the way on up. So would this time be the same? If you'd rather skip the weekly commentary, the short answer is, no. He sees us in a range-bound state still, between 1100 and 1250.

As he writes to conclude his letter

"For the time being, we expect that markets will remain in their trading range as the downside macro risks compete with attractive valuations and strong fundamentals. Should we continue to see progress and improved clarity around the European debt crisis, however, stocks could be poised for improved longer-term performance."

So it looks like our man is not yet ready to get optimistic, though there is a glimmer of hope in his writing. I'll be checking in on Doll's letters if the market continues to dilly dally. The last thing you would want to do is find yourself lulled to sleep by this market and miss an entry point for a ride up. Speaking of, getting lulled to sleep sounds pretty good right now. Til next time.

-Ben

It's all German to me

A few days back, I found myself to be very aggravated by the time 4pm rolled around. Why? Because the markets were completely headline driven, and the headlines seemed baseless. Europe will have a comprehensive plan by the 23rd, no they won't, well maybe next week... now definitely we'll have a lot of details laid out by next Wednesday... It's maddening. Trying to figure out what's next in Europe and trading on it with anything less than superior access to information is a loser's game. You will probably see a lot of stop orders getting filled, only to watch the market return to the levels you initiated your trade. As I reflected, I saw I was annoyed because I was trying to formulate opinions about something that for all we know, the European leaders might not have even fully explored.

So perhaps its best not to trade at all. If it is a headline risk guessing game, then trading simply becomes blackjack (assuming you can't count cards). Of course never happy with this as a theoretical answer (though it might well be practically prudent), I started thinking of whether one could play the market from one side or another while accepting his inability to front-run headline risks. Today, I saw Thomas Lee, Chief JP Morgan equity strategist on TV making his usual bull case. When the S&P was around 1275, he had said that 1250 (the previous low) would hold and stay as the lows for the year. I like that he was out there with an opinion, but I kept in mind that he was a bull 12% + higher. But then he started talking about just how much money is sidelined, and that with stocks trading historically cheap, the eventual return of capital to the markets would push us higher. I don't know if it was his reasoning or those glasses Lee wears, but I found it compelling.

Another bull case being tossed around is that earnings in American stocks are cheap enough to buy even if Europe does a poor job of resolving its issues. So do the math, and tell me how x% decline in European economies wouldn't impact earnings of U.S. companies enough to justify multiples. The problem I have with this case is that it doesn't take into account what would happen if banks had a liquidity crisis. If the French banks have to take massive markdowns on their assets and become insolvent, the question becomes whether or not the system would freeze up. From there, the question is how well and swiftly could European policy makers respond? What we have seen thus far from Eurozone policymakers does not exactly bring me comfort in envisioning such a scenario. But like Art Cashin says, betting on the end of the world only works once.

From a strategy perspective, I think it is important to remove oneself from the madness. Rather than listening to every headline, why not observe that the market seems to rebound on rather meager promises. "Give us another week, and it'll be great", and the market rallies. If you believe that this is an indication of just how desperate investors are, then steer clear. If however you think (as I do) that what the market really wants is to see  is some unity among policymakers, then maybe our bullish friend Thomas Lee is right. After all, it seems those Euro policy makers seem to know what to say to find a little support for the market. I still think there is downside potential, but for the longer term investor (and this is admittedly a cop out because "the long term investor" can remain in denial about being wrong for the longest) it might make sense to look at starting to average in to long positions. I really don't see the rush because an upside move is still more likely to be methodical than a down move. Still, I think investors fearing the end of the world might want to think about returning to the market soon.