Friday, September 23, 2011

What Happened To Silver?

I suspect there will be more to this story as the weekend progresses, but the first trigger for today's fall just crossed the news wire:

The CME just increased silver margins by 16% and gold margins by 21%.

Increasing margins while an investment is already falling in price creates forced liquidations in the market.  Let me explain why: 

Most hedge fund managers are heavily leveraged in their portfolios.  That means they will borrow money to make a bet on price direction.  Let's say that the margin requirement on silver is 10%, to make the example easy to understand.  A hedge fund (or any investor) may purchase $100,000 in silver, but only have to use $10,000 in capital.  The remaining $90,000 is borrowed from the exchange.

If margin requirements are increased by 21%, that means they must now put up $2,100 in new capital to keep their silver position.  What if they don't have $2,100 available?

They must sell off some of the $100,000 of total silver purchased.  In order to now have a 12% margin they must sell off $16,000 in silver and reduce their position down to $84,000.

This is not a big deal if the price of silver is stable, but if it is already falling in price it becomes magnified.  If silver falls in value by 10%, then the investor's entire $10,000 margin (or buffer) is now gone.  Think of it like a down payment on a home.

So now the customer must come up with the 10% in margin required to keep the account open.  For the CME to raise margins during a week when silver fell by 27% causes any weak hands to have to flush their positions in order to stay alive.  It is a self re-enforcing cycle.

It is also the reason I never recommend purchasing silver or gold on margin.  As an investor you want to be able to ride through these free fall drops and purchase more if you have the opportunity to capitalize on other's misfortune.

Silver Falls 27% In 48 Hours

Do not panic. 

If you own precious metals this is not the time to be selling.  This is the time to begin using the cash you have been building for months to take advantage of opportunities like today.

There are rumors that a hedge fund or multiple funds are currently liquidating.

I am personally, and I am recommending to people that I advise, stepping in strong here and purchasing physical silverI understand that the market could fall heavily from here.  I will buy more.  I don't want want to sell tomorrow.  I don't want to sell next month. 

I care about how many ounces of physical silver I own when we reach the mania stage of this bull market.  Stay focused on the big picture.

I am not a financial advisor.  Make sure you contact one before making any investment decisions.

Is The American Dream Still Alive?

Incredible look at the optimism that still exists in the housing market.  After being slaughtered for 5 straight years, Americans are as excited as ever to line up for their piece of the American dream: home ownership.

Ironically, when the housing market finally bottoms and owning a home makes sense as an investment, no one will want to purchase. 

Bernanke Disappoints: Markets Plunge

The market was not pleased with Bernanke's announcement this week on future monetary policy.  All assets were hammered across the board and around the world yesterday as investors rushed into treasuries and cash.  The crushing move down has continued through to this morning.

Bernanke announced, as I discussed in Operation Twist: Complete Analysis, that there would be no more additional money printed now nor did he hint that more was coming.

The Fed is currently still purchasing assets in the open market through "QE lite."  As assets that they own mature (someone pays off a mortgage that the Fed holds), the Fed is reinvesting that money back into the market to keep their balance sheet the same size. 

The markets wanted more, and they now realize they are on their own in the face of the next leg down of America's current depression (which began in December 2007).  All economic indicators continue to plunge and unemployment + housing, the bedrock of our recovery, appear ready for their next move down.

Meanwhile, things in Europe are getting worse by the hour.  Portuguese bonds exploded higher yesterday and the contagion is spreading.  Stocks are falling throughout Europe, led down by the banking system which is coming to grips with its impending doom.

I discussed in detail the status of the European meltdown in European Web Of Debt, and I will be updating the situation as it progresses.

In the actual market, assets are beginning (not there yet) to look attractive to purchase for the first time in years.  My favorite assets...

Canadian dollar
Australian dollar
Brazilian real
Asian stocks and currencies
Precious metals and miners

...have been slaughtered over the past week, and if we get the real flush out that I have been waiting for since May of 2010, then it will finally be time to begin putting some of your patient cash back in the market.

I will update you when I feel it is safe to re-enter.  In the meantime, hope for lower prices on the strong assets.  Put together your shopping list now.  They will most likely be sold off during another market collapse.

Jim Rogers On Reuters

Jim Rogers discusses the current investment outlook, Europe, and what he is holding today.

"When you look at the austerity in Europe, every country is projected to have higher debts in 5 years."

Thursday, September 22, 2011

Commercial Real Estate Prices Rise

Commercial real estate prices rose 5% in July according to Moody's.  Prices are up 1.2% from a year earlier.

Investors continued rushing into properties this summer believing that the economy has turned upward.  As the economy now continues to roll over, the cost to finance properties will rise and demand will fall as fear enters back into the market.

We are far closer to a bottom than we were in 2008 (see chart below), but those investors who remain patient will be rewarded over the next 24 months.

Chart courtesy of Calculated Risk.

Wednesday, September 21, 2011

Operation Twist: Complete Analysis

Back in August, in Gold Corrects: What Next?, I wrote that I felt another round of Quantitative Easing (QE) from the Federal Reserve was on hold and the next form of stimulus would come from our federal government in the form of a job stimulus act.

A few weeks ago, the job stimulus act was announced and I discussed the details in The Jobs Act.

In August, I wrote that the next move for the Federal Reserve would be a program called Operation Twist.  I promised I would discuss the program if it were announced and today we got word that it is on the way from chairman Bernanke.

The program was used during the 1960's as a strategy to lower the interest on longer term bonds.  To explain the program in simple terms, imagine that the Federal Reserve has $1 trillion in bonds on their balance sheet.  Let's say this is how they are spread out:

$100 billion - 1 year bonds
$400 billion - 2 year bonds
$400 billion - 5 year bonds
$100 billion - 10 year bonds
$1 trillion total balance sheet

Bonds that have a lower "term" (number of years) on them are considered safer.  Why?  Let me give a quick example with how government bonds work:

Two men, Larry and Michael, decide to take $100,000 they have saved and purchase government bonds.

Larry decides to be "safe" and purchase $100,000 in 2-year government bonds.  The interest rate on these bonds (real prices as of today's market close) is .15%.

That means Larry will collect $150 per year in interest ($300 over two years) and at the end of the two years the government gives him his $100,000 back in full.

Michael thinks only a fool would accept such a low payout.  He purchases $100,000 in 30-year government bonds.  The interest rate on these bonds (real price as of today's market close) is 2.99%. 

That means Michael will collect $2,990 per year in interest ($5,980 over two years), but at the end of the two years he still has 28 years remaining on his bonds.

Michael doesn't care. He has dinner with Larry and mocks him for only earning $150 per year while he has raked in over $6,000.

Then something changes.  The endless trillions of dollars that the Federal Reserve has printed begin to enter the economy and the value of the dollar against other currencies begins to fall.  Imports become more expensive and inflation begins to rise.

In order to combat inflation, investors are now asking for a higher interest rate.  If annual inflation rates are now at 5% per year, new investors begin asking for 6% interest per year in order to cover the cost of inflation and get a real return on their money.

Michael is now nervous.  He decides he wants to sell his bonds and get his money back.  After all, his financial advisor told him that bonds are safe and they have never gone down for as long as he has been in the business. (They have been rising for 30 years)

When Michael calls his advisor he finds out that with interest rates now at 6% instead of 3%, his bonds are now worth $50,000 instead of $100,000.  His retirement money is now cut in half and interest rates are continuing to rise every month with inflation.

Larry puts his $100,300 (after adding his interest) back into the bond market and is now getting a 6% return per year on his $100,000.  Dinner parties are now very different, Larry usually picks up the tab.

Back to the Federal Reserve and Operation Twist...
(This is a hypothetical balance sheet to make it easy to understand)

$100 billion - 1 year bonds

$400 billion - 2 year bonds
$400 billion - 5 year bonds
$100 billion - 10 year bonds
$1 trillion total balance sheet

The Fed has announced that over the next 9 months they will be selling $400 billion in bonds with 3 years or less, and buying $400 billion in bonds at 6 and higher years (bonds go up to 30 years).

This is not an increase in the money supply.  It is only meant to "twist" their balance sheet and lower the interest rate on longer dated bonds.

9 months from now the hypothetical balance sheet will now look like this:

$50 billion - 1 year bonds

$50 billion - 2 year bonds
$400 billion - 5 year bonds
$300 billion - 10 year bonds
$200 billion - 30 year bonds
$1 trillion total balance sheet

Why would they do this?

It lowers the cost of borrowing for businesses and consumers who usually have their rates set against either the 10 or 30 year government bond.  Mortgage rates fall into this category and it is another tool the Fed is using to drive down rates.

The surprise today was that the Federal Reserve decided to buy 30 year bonds.  Many did not think they would move that far out on the risk curve.  They have decided to buy $120 billion in 30 year bonds, which coincidentally, is the exact number of new 30 year bonds the government will be selling over the next 9 months.

In other words: the Fed is buying all the new issuance.

While this may not stimulate the market or economy with new money, in addition to lowering rates it has provided the Federal Government a blank check to go out and spend.  Bernanke has handed the check book to Obama and if you have turned on your television the last 2 weeks you know that Obama is ready to begin writing checks.

What are the dangers?

The first is danger is for the Fed itself.  If interest rates rise, the assets they are purchasing would be "underwater" in value (example above).  This does not mean the Fed would go bankrupt because they always have the ability to hold the bonds until they mature.

However, in normal times when inflation is rising, the Fed lowers the money supply by selling bonds back to banks and taking away their cash.  This takes money out of the system.

If their assets are underwater they will not be able to sell them without taking the writedowns.  They will be trapped and helpless to stop the inflation.  This is extremely important to understand when forecasting what is ahead.

Second, is that banks make money by borrowing short term bonds and lending at long term rates.  For example, they will go into the open market and borrow $300,000 in 2 year bonds.  They then lend this money to a happy new home owner in the form of a mortgage for 4%.  They keep the spread.

If the Fed lowers the longer term rates, the banks profits will fall at a time they desperately need them.

What is the effect on the markets moving forward?

I believe the markets are headed for trouble based on how quickly the banking system is collapsing in Europe, a topic I have discussed in detail the past few weeks.

A sharp fall in the markets will open the door for the next round of Quantitative Easing, which I believe is right around the corner.

Prepare for a combination of both fiscal and monetary stimulus heading into the next election, as they will do everything in their power to juice the markets and economy one more time before the real collapse arrives.

Keep plenty of dry powder (cash) available to purchase assets on sale, but continue to hold your strong core positions currently in place.

Housing Starts: Recovery Yet?

Monday, we looked at the home building sentiment indicator, which came in abysmal.  Yesterday, we received the home building starts for the month of August. They reinforce that the depression has remained intact despite record new low mortgage rates month after month.

The long term chart going back to the 1940's (when our population was much smaller in size).

Jim Chanos On China

For all those who are firm believers in the Chinese miracle, please take in the caution coming from legendary short seller Jim Chanos.  He is the man who reviewed Enron's financial statement 10 years ago and had the courage to short the stock at its high and ride it down to zero.

I personally am bullish on China (and Asia's) currencies in the short and long term.

I am very bearish on Chinese real estate and stocks in the short term, but I am very bullish on their prospects over the next 20 years.  China will own this century in terms of economic growth, just as the United States was the growth engine of the world during the 1900's.

From Chanos on what he sees now:

"A lot of people are assuming that half of all new loans in China are going to go bad. In fact, the Chinese government even said that last year relating to the local governments. If we assume that China will grow total credit this year between 30% to 40% of GDP, and half of that debt will go bad, that is 15% to 20%. Say the recoveries on that are 50%. That means that China, on an after write off basis, may not be growing at all. It may be having to simply write off some of this stuff in the future so its 9% growth may be zero."

A slow down in China would completely revalue expectations for global growth and projected earnings for future stock prices. (What drives the price of stocks today)  This will in turn create a policy "response" from Central Banks and governments around the world.
Jim Chanos Interview With Bloomberg: Click Here

Waiting For Operation Twist

The Fed's announcement on the future direction of monetary policy is announced today at 2:15 PM.  The market has Operation Twist baked into the cake, but Bernanke may come with additional shock and awe.  I will provide a full analysis after the speech.  Until then......

Monday, September 19, 2011

Home Builder Confidence September

It's been a while since I've commented on the Home Builder Confidence index. The reason?

Nothing has changed.

The index clocked in at 14 for the month of September, down from 15 in August. Anything below 50 shows contraction or a negative outlook moving forward, meaning we are currently in a depression for the industry.

This is obviously good news for the housing market long term as new supply is completely unnecessary.

The long term chart, going back to 1985, courtesy of Calculated Risk:

Sunday, September 18, 2011

Kyle Bass On Europe's Future

CNBC, who I constantly degrade for their poor content, ran an excellent segment this past week called Delivering Alpha.  They had some of my favorite figures in the financial world, including Bill Ackman who had a phenomenal segment regarding the coming appreciation of the Hong Kong dollar. (An investment I agree with and recommend betting on)

The most interesting interview of the segment for me came from Kyle Bass who was one of the stars in Michael Lewis' bestselling book "The Big Short."

Kyle discussed how he sees events unfolding in Europe in both the near and long term.  As with Ackman, I agree with him close to 100 percent.

European Web Of Debt

Earlier in the week I discussed the hidden problem for the European banking system in The Real European Crisis Explained.  Today we will look at the portion of the sovereign debt crisis that is visible. 

The following graph is an incredible visual of who owes who in the European Union.  When I use the terms "interconnected" and "contagion" this chart demonstrates exactly what I'm talking about.  It is a true web of debt. (Click for a larger visual)

I will be coming back to this chart many times as we move round by round through the sovereign debt crisis, but let's begin with Greece since they are clearly the first country that will either default or receive the next round of bail out money.

The following graph provides a more focused view of who is on the hook for Greek debt in terms of the European banking system.

As you can see, French banks have a tremendous exposure to Greek debt.  It is why you have watched the stock prices for French banks and their stock index as a whole plunge over the past few weeks.

How big is the problem is the debt problem in France?

America's largest 3 banks currently have $5.86 trillion in debt, or 39% of America's GDP. (GDP = total size of American economy)  This number is way too high.

The largest 3 French banks currently have $4.7 trillion in debt, or 250% of France's GDP!  The banks are levered 30 to 40 times their available capital.  This means if they lend out $100, they have $3 in reserves against loan losses.  If the bank's debt falls in value by only 3%, they must close their doors.

Estimates now show that Greek debt alone will need to be written down between 50 - 90%. 

Just for fun, let's take a look at what French bank's exposure is for Spanish debt.

Or how about the big daddy - Italy.

This is only a discussion on France.  Look back now at the web at the top of the page and you can see that every country is in the same situation.

This week the Federal Reserve re-opened their swap lines with the European Central Bank.  This means they will provide dollars in exchange for euro's, a program used heavily during the financial crisis of 2008.

Every day we move closer to the breaking point.  If stock markets continue to fall (the German stock market is down close to 30% over the past 2 months) then central banks will do everything in their power to preserve the system.  While gold and silver may fall during the panic it will only be providing another attractive entry point, similar to what we experienced during the fall of 2008.

h/t Reuters, Zero Hedge

Nassim Teleb On Cash

I very rarely cut and paste, but I had to this morning after reading this speech segment from one of the greatest minds on our planet today: Nassim Taleb.  The discussion is on the importance of having cash available before a crisis hits to be prepared to purchase assets on discount, a topic I discuss relentlessly.  Please note that when I discuss cash, I mean liquid currency (does not have to be US dollars) which includes gold and silver.  Hat tip to Paul Kedrosky's Infectious Greed.

All emphasis is mine:

Nassim Taleb (author of The Black Swan) at U Penn:

People kept telling me I was an idiot for years [because] I didn’t invest in markets.
I don’t invest in the stock market because I think it’s a sucker’s game. I make my money and I put it in a repository [of value]. Or sometimes I just do these bets for entertainment, nothing else, so I can have a conversation with someone once in a while on a train or on a plane. That’s the only reason. So I stayed in cash, for years, and then realized that the value of my cash became monstrously high after the crisis. The last 12 years, the stock market did nothing, and cash yielded 40, 50, 60 percent.

Cash gives you an option when other people go bust. That’s what Kennedy did. Joe Kennedy, the father, got rich not from investments but from negative investments. In other words, he had no investment when other people were busted. [Take] the story of the two brothers [one of whom makes $4 per share a year while carrying no insurance against being wiped out, one of whom makes $2 per share with maximal insurance]. If the $2 brother can survive—without being kicked out by the board and replaced with some short-volatility fellow who doesn’t understand anti-fragility—then when the other brother goes bust, he’ll be able more aggressively to buy his inventory—his refrigerator, his car, everything, even his house—for nothing. You see the idea? So you have to think in terms of dynamics of cash: that it’s not a sissy trade.

There’s something called action bias. People think that doing something is necessary. Like in medicine and a lot of places. Like every time I have an MBA—except those from Wharton, because they know what’s going on!—they tell me, “Give me something actionable.” And when I was telling them, “Don’t sell out-of-the-money options,” when I give them negative advice, they don’t think it’s actionable. So they say, “Tell me what to do.” All these guys are bust. They don’t understand: you live long by not dying, you win in chess by not losing—by letting the other person lose. So negative investment is not a sissy strategy. It is an active one.