Friday, December 19, 2014

Fannie Mae Rolls Out The New 3 Percent Down Program

I received an email this week from a mortgage lender with the details on Fannie Mae's new 3% down mortgage program. It appears to be targeting first time home buyers (the group of Americans that have been reluctant to join the home buying party since the last crash). The lending restrictions on the program will continue to loosen until we arrive at the next major crash and American tax payers once again have to write a check for hundreds of billions of dollars in losses.

No one pays attention to the cause, but they are always very upset when the effect arrives. Here are the major details of the program:

- 30 year fixed mortgage
- Primary residence only
- At least one of the borrowers must be first time home buyer
- Minimum credit score 640
- 3% down payment (which can be a gift)

A "gift" means that if a young American is purchasing a $300,000 home, they can get the $9,000 (3%) down payment needed from Mom and Dad. So a young American fresh out of college that has found a job and has $65,000 of student loan debt (government financed) can instantly get another $291,000 in mortgage debt (government financed) without having to save a penny. All they need is a $20,000 car loan (government financed) and a nice 0% deferred interest plan on $15,000 to furnish the home and they are officially living the American dream.

$400,000 in total debt (including the $9,000 they owe Mom and Dad) which they can now try to pay down for the rest of their life. The economy grows due to the credit expansion, the rich get richer, and 15 years later that young American wonders why the middle class is running in quicksand while slowly sinking.

God bless America.

Thursday, December 18, 2014

Long Term U.S. Treasuries Are Having An Incredible Year

It may surprise many Americans who pay much closer attention to the stock market ticker, but entering the trading day yesterday long term treasury bonds were having their 5th best year in history, up 28.2%.

This return has come mostly through appreciation as bond values rise as interest rates fall. We recently discussed how every financial forecaster polled by Barron's predicted higher stock prices in 2015. What we did not review is that every one of them also predicted lower bond prices (higher yields).

While I think both asset classes are at nosebleed dangerous price levels (I would rather own foreign assets, commodities and cash), sentiment appears to favor owning treasury bonds over U.S. stocks in the new year.

Jim Rickards Walks Through What Is Really Happening With Russia

Jim Rickards helps explain to Bloomberg the difference between Russia's corporate and sovereign debt. Where is the corporate debt actually located, meaning who lent to these Russian companies? It was emerging markets and American 401k's, which will feel the impact of the contagion involved with coming defaults (remember how U.S. lenders packaged and sent subprime mortgage time bombs to countries all over the world?).

As he eloquently puts it, "if you want a financial war United States, you have it."

Wednesday, December 17, 2014

Terrified Russian Citizens Line Up To Purchase U.S. Dollars

Russian markets have been in a panic during the last two days, which I discussed in detail yesterday. Over the past 24 hours we have seen pictures of Russian citizens lining up to exchange their rubles for U.S. dollars.

Russians are not lining up at stores to exchange their rubles for gold, which I find fascinating. Here is how gold has performed over the past two months for any Russian that decided to purchase some insurance on their portfolio in mid November.

It is bizarre to me that the collective public around the world has not yet put the big picture together in a world where financial information is so readily available through the internet. The lines you see of Russians scrambling to exit their currency will soon be replaced with pictures of Japanese citizens in complete terror. Then the panic will eventually spread to another country and then another.

This is not some incredible precognition of the future. It is common sense. Paper currencies have have no intrinsic value, therefore there will always be rolling chaos around the world. One day you wake up and everything is fantastic, and the next day you will wake up to see all your friends in line trying to purchase gold. The global financial system today is far less healthy today than it was entering 2008, with only confidence holding together the mirage by a thread. Confidence evaporates in minutes in a fiat backed monetary system.

Ironically, as I discussed yesterday, Russia's currency is far healthier on paper than the Japanese yen or U.S. dollar. Financial advisors in the United States recommend moving your assets from U.S. stocks back to U.S. bonds in some sort of percentage (like 60% to 40% for example). Your assets are considered "diversified" because U.S. stocks and bonds can "never" fall at the same time. There is no recommendation today to hold a percentage of your assets in cash (foreign or domestic), and there is no recommendation to hold a percentage of your assets in precious metals. Both asset classes are considered truly insane within today's euphoric stock and bond mania. I'm not telling anyone to put 100% of their investments into cash or gold, I'm only saying investors should potentially review a holding of 100% U.S. stocks and bonds.

Over the past 60 days residents of Russia who were "diversified" in Russian stocks and bonds saw a large percentage of their life savings disappear in moments. Now they are running to exchange what is left into U.S. dollars. Over the short term it may be a great move, but over the long term they will soon realize they are only jumping out of the frying pan and into the fire.

Jim Grant On The Fed's Third Mandate & Their Impact On Emerging Markets

Tuesday, December 16, 2014

Russian Financial Markets In Complete Panic

To say there is full blown panic in the markets surrounding Russia and oil is surely an understatement. While I have been discussing the oil price decline over the past few weeks (oil has now collapsed down to $54), Russia's currency decline has been even more severe over the past year.

The Russian ruble began the year at 33 against the U.S. dollar and fell 13% yesterday alone to finish the day at 66 (then moved past 70 in overnight trading). That is a staggering 53% decline in a single year. The chart below shows the parabolic decline in the Ruble over the past few weeks.

Last night the central bank announced a surprise rate hike of 6.50%, bringing the benchmark interest rate to 17%. This is the sixth rate increase this year.

To help keep the magnitude of this rate increase in perspective, the U.S. currently has rates held at 0.0%. Just imagine the sheer terror that would engulf the U.S. markets if the Fed announced a surprise overnight rate increase of 50 basis points (0.50%). The Russian central bank just increased it by 6.50% overnight!

The Russian ruble and the price of oil are intertwined in this story. Many assume the price of oil falling will completely destroy revenues for oil producers within Russia. However, the currency has fallen further than the price of oil over the past year meaning revenues priced in Russian rubles are essentially flat (or just above) where they were last year.

In 1986, oil fell from over $30 a barrel down to a range of $11 - $13 where it stayed through 1989. This was a large contributor to the fall of the Soviet Union. Many making comparisons to that period today are forgetting the importance of the currency decline mirroring oil's fall. In addition, Russia has far less government debt than they did during that period.

After experiencing a sovereign debt default in 1998 Russia learned the important lesson of holding an enormous foreign reserve war chest, which now sits at $416 billion (after selling $80 billion into the market already this year to defend the ruble).

Here's the best way to explain how this war chest is deployed:

If the Russian ruble begins to fall in the foreign exchange markets, the central bank can enter the markets and sell foreign reserves (the U.S. dollar for example) in exchange for Russian rubles. This has the obvious effect of driving up the value of the ruble (because they are buying it), or stemming its decline. By having this reserve available and promising the markets they are always ready to step in and use it keeps speculators on their toes.

Other countries around the world, such as Brazil, India and China, have also been building these enormous war chests of foreign reserves since the last emerging market crisis in 1998. India was able to stop a mini-crash on the rupee in 2013 following the U.S. Fed taper tantrum.

I will explore my thoughts surrounding the importance of these global reserves in the future (they are part of the reason I am extremely bullish long term on emerging market asset classes), but let's get back to the star of the present; Russia.

The Russian government currently has one of the cleanest balance sheets on the planet. Their current debt to GDP level of only 13.41% looks incredible compared to most sovereign debtors around the world. On top of their foreign reserve savings and abundance of natural resources available to export to the world, Russia has been accumulating gold. While that is unimportant to today's story, it will become extremely relevant following the next major financial collapse when the current monetary system will need to be restructured. Those that come to the table will do so with their gold reserves, and those countries will make the new rules. But again, that is a story for another day.

Russian banks and companies owe nearly $700 billion in external debt, denominated mostly in dollars. With the ruble falling by 50% over the last year, it essentially doubles the burden of paying back this $700 billion. With sanctions put in place by foreign lenders due to Russia's involvement with Ukraine, many of these smaller companies and banks have been shut out of the debt markets. There is about $125 billion of debt that must be rolled over (refinanced) by the end of 2015. Many of these companies have built up foreign cash reserves (similar to the government) to prepare for an event like this happening. Others will have the opportunity to work with the government for help. The rest will be in serious trouble unless the debt markets re-open for them.

The smaller cap Russian companies have seen their stock prices destroyed across the board over the past year. Many are down 80% to 90% with price to earnings ratios now in the low single digits. Investors with b*lls of steel and the ability to determine which companies will successful refinance and survive through this period will experience unbelievable long term profits by taking positions in the market today.

There may be other long term pockets of opportunity in Russia as well.

While the banking and corporate sector of the Russian bond market is murky, we know where the Russian government sits. They owe $38 billion of debt denominated in U.S. dollars, with only $6 billion of interest and principle payments due by the end of 2015. Remember, they currently hold over $400 billion in foreign reserves so they certainly do not need to panic over this $6 billion due in the next year.

A 3 year government bond in Russia currently yields over 18%. That means the government will pay you 18% per year to hold their bonds and at the end of the third year you will receive your principle back. What is the danger of purchasing such a bond? The government could default and you may only receive a portion (or none) of your investment back. Or, if you purchased the bond in Russian currency it could continue to free fall in value over the coming months. If the currency falls by another 50% over the next year, you will feel little excitement over your 18% return (which would only now equal a 9% real return in U.S. dollars with the principle you would receive back at the end of the three years cut in half). With the currency falling by 13% yesterday alone, it is certainly not for the faint of heart.

But what if the currency ever stopped falling? What if oil ever stopped falling? What if the geopolitical tensions loosen just a bit over the coming months or year? The markets are pricing in World War III and a global depression for many Russian assets. That outcome many certainly arrive, but what if it didn't?

Please understand I'm not telling anyone to purchase Russian stocks, bonds or currency which are all in complete free fall. I'm only trying to be a contrarian voice at what could be close to the absolute peak of panic in Russian markets. There are many investors I consider extremely intelligent looking for value in this market at the moment, but it takes a surgeon-like financial skill set to know where to enter and make picks.

Sunday, December 14, 2014

100% Of Barron's Market Pros See U.S. Stocks Higher To Finish 2015

U.S. stock prices will soon enter their sixth year of the current bull market. We are already in the third longest bull market in market history. Stock prices and profit margins are resting at all-time highs, prices to actual earnings are at nose bleed levels, and there could not be a better word than consensus to describe the sheer optimism toward U.S. stocks entering the new year. 

10 out of 10 professionals polled by Barron's see stocks finishing 2015 at higher levels than they are today. As long as they are in full agreement no one will lose their job next year because "no one could have seen a stock market decline coming."

And the recent cover which needs no introduction: "This Time Is Different."

Silver American Eagles Reach Record Sales In 2014

After selling out of eagles in November, the US Mint was still able to record an all time record in coins sold at 42.9 million this year (so far), topping the previous record of 42.7 million.

Coins are about 50% less expensive than they were through most of 2011, which continues to shock analysts who cannot understand why someone would want to own two coins for the price of one.

With the all-in cost hovering around $20 an ounce to pull physical silver out of the ground, insatiable physical appetite for the metal around the world and a steady stream of new industrial uses coming online every year it will be interesting to see how long silver can remain at these ridiculously low prices.