Tuesday, February 8, 2011

Survivor Trading System - Trades of 7 February

I trades di Survivor System del 7 Febbraio. I risultati real-time sono a disposizione al seguente link: http://www.box.net/shared/5vajnzc4cp

Trades of Survivor System on 7 February. Real-time results are available at the following link: http://www.box.net/shared/5vajnzc4cp


Ninja Futures Trading Systems - Recently Closed Trades

I trades di Ninja Futures System chiusi ieri 7 Febbraio. I risultati real-time sono a disposizione al seguente link: http://www.box.net/shared/5vajnzc4cp

Trades of Ninja Futures System closed on 7 February. Real-time results are available at the following link: http://www.box.net/shared/5vajnzc4cp

World coffee stocks slip as exports soar

by Agrimoney.com

World coffee exports jumped by nearly one-third in December, led by demand for the arabica variety, experts said – as prices for highest-grade Kenyan beans hit the equivalent of $20,440 a tonne.
World coffee exports in December were, at nearly 10.4m bags, up 32% on the same month in 2009, data from the International Coffee Organisation showed.
The increase was particularly strong in arabica beans, the type traded in New York, for which exports jumped by some 40%.
By country, Brazil, the world's top producer and exporter, saw a 35% jump to 3.4m bags in shipments, helping make its four-quarter performance a record one, at 10m bags.
'Coffee was needed' 
The boost took exports for the whole year, which had been running 1.4% lower year on year, to 97.5m bags, a 1.4% increase over the 2009 figure.
A rise in shipments might be expected, given that 2010 was an "on" year in the Brazilian cycle, which sees alternate seasons of stronger and lower production, Jose Sette, the ICO executive director, said.
"It is unlikely that this performance will be maintained in crop year 2011-12,"
However, he noted that prices had maintained their strength despite the splurge of supplies onto export markets, and indeed have set a series of 13-year highs in New York and two-year tops in London, which trades the robusta beans of which Vietnam is the top producer.
"It looks like this coffee was needed," he said.
'Very low stocks' 
Indeed, the ICO flagged that opening inventories in exporting countries were "unlikely" to have exceeded 13m bags in 2010-11, compared with 20.9m bags a year before, and the lowest since at least the 1960s.
"Stocks are at very low levels," Mr Sette said.
This tightness was also reflected in certified inventories  held by exchanges which, in New York, fell for at least the 12th successive month in January to 1.85m bags, down 44% year-on-year.
Stocks of London's robusta beans edged higher last month but remained, at 3.88m bags, down 31% on January 2010.
All-time high
The short world supplies of coffee, coupled with concerns over north African unrest, were viewed as behind a further increase in the price of Kenyan coffee to a record $1,022 per 50kg bag at the weekly auction in Nairobi.
Kenya's supplies, which are particularly prized for their quality, have been further hit by weather setbacks.
The country, unlike African neighbours, has suffered poor coffee growing weather with unusually late and heavy rains early in 2010 damaging flowering before dry conditions damaged yields of fruit which did set.
Continue reading this article >>

Bullish On Gold All The Way To $1,600

by Agustino Fontevecchia

With gold prices falling since the beginning of 2011 and the prospects of an economic recovery gaining traction, many have doubted whether the incredible rally in gold prices is sustainable. The bullish argument can be made by looking at fundamentals underpinning the market, though, as gold investors will see the market tightening around stagnant production and higher demand through 2011.

Research by Standard & Poor’s MarketScope Advisor pinpointed a few of the organic trends that will prop up prices through the year. In the note, analysts estimate that gold prices will end 2011 around $1,600 an ounce, giving the precious metal an upside of about 20% from early February prices.

Stagnant or declining gold production will be one of the main market forces supporting higher gold prices this year. According to S&P’s research, production will remain stagnant for the next several years “as old mines are becoming depleted” and significant discoveries fail to be made. Global mine output in 2010 reached 2,652 tons, only 1.2% above 2000 levels, leading S&P’s research team to conclude that “production will remain stagnant for the next several years.” Among producers, they suggest Barrick Gold, Newmont Mining, and Randgold Resources. The research team expects “sizeable gain[s] in sales and earnings versus 2010 levels,” with EPS projected to grow 50% for the producers they follow. (Read Bob Lenzner’s piece, Gold Is Not The Ultimate Bubble Yet).

Demand-side fundamentals will be price-drivers for gold in 2011. Accommodative monetary policy in developed economies and an extended low-rate environment will both pump up demand for gold and reduce the opportunity cost of holding it as an investment, reads the note. Quantitative easing expands the money supply and possibly “leads to rising inflation and the debasement of the currency” in which it’s applied; this will send capital in dollars, pounds, yen, and many other currencies out in search for yield. As evidenced by Ben Bernanke’s last speech and the FOMC’s last statement, rates will remain at the almost 0 range for an extended amount of time, rendering treasuries unattractive and increasing the appeal of gold as “monetary reserve asset.” (Read Bernanke’s Victory? Chairman Speaks More of Deficit Than QE2).

This last trend, that of gold as an alternate monetary asset, will be furthered by nations seeking to diversify their reserves as a reaction to a falling dollar with an uncertain future ahead of it. China leads the way in terms of reserve accumulation, but Brazil, Russia, Japan, and various other East Asian nations have been amassing huge fortunes which are now at risk due to U.S. economic and monetary policy.

Demand for gold has come from everywhere. Added to the likes of billionaire investors George Soros and John Paulson, the central banks of emerging markets including China, India, and even the oil producers, are retail investors. Through the SPDR Gold Shares ETF (GLD), investing in physical gold has been democratized and opened up to almost anyone (S&P suggest GLD as a way to tap into rising gold prices).

Even retail investors in mainland China have been revving up their appetite for the yellow metal. According to a piece by Eric Sprott and David Franklin published in ZeroHedge.com, “Asian demand for physical gold and silver is akin to a tsunami.” The piece fleshes out how a new investment facility provided by the Industrial and Commercial Bank of China (ICBC) and the World Gold Council has opened the door to investors in mainland China to “accumulating gold through a daily dollar averaging program.”

“Chinese retail demand for gold increased by 70% from October 2009 to September 2010, representing a total of 153.2 tonnes of gold imports. Yet, over the same period, the demand for gold jewelry rose by only 8%. There is a clear trend developing for Chinese investment in gold as a monetary asset, and China is buying so much gold for investment purposes that it now threatens to supersede India as the world’s largest gold consumer,” reads the piece. Now, through the ICBC Gold Accumulation Plan (ICBC GAP), 1 million new accounts have been opened to invest in gold, and, as the ICBC is “the largest consumer bank on earth with approximately 212 million separate accounts,” the prospects for this program’s super-charged growth is huge, say Sprott and Franklin.

The authors estimate that if the limited program were opened up to all ICBC depositors and to the next four largest Chinese banks and the rate of gold purchases followed the same growth pattern exhibited in the “test period” mentioned above (i.e. 1 million accounts since April 1), then it would result in gold purchases of an extra 300 tons of gold per year, or over 10% of estimated 2010 global gold production. “The ICBC Gold Accumulation Plan and other alternate methods of investing in gold have the potential to overwhelm current supply in the gold market.”

While many consider gold to be overbought and due for a major correction, it seems like fundamental market forces are positioned to support the precious metal’s assent even further. S&P’s MarketScope research team suggests looking into the market vectors gold mining ETF (GDX) and the basic materials select sector SPDR (XLB) for investors looking for additional ways to express their bullish sentiments.

Continue reading this article >>

China drought threatens to 'devaste' wheat yields

by Agrimoney.com

The world's biggest wheat crop – China's – faces a "critical situation" if a drought across most of its range does not break, the United Nations has said, warning that cold temperatures could also "devastate yields".
The UN's food agency warned that "substantially-below normal" rainfall over the last four months, , had put some 5.2m hectares of winter wheat, an area significantly bigger than Denmark, at risk of drought damage.
By lowering snow cover, the conditions had also left the crop vulnerable to damage from low temperatures during the rest of the winter.
"Thus the ongoing drought is potentially a serious problem," the UN Food and Agriculture Organisation said in a so-called "early warning" alert.
"Adverse weather, particularly extreme cold temperatures, could still devastate yields.
"The situation could become critical is a spring drought follows the winter one, and/or the temperatures in February fall below normal."

'Serious risk' 
The warning adds China to the list of countries, including Canada, Kazakhstan and Russia, whose wheat crops have suffered severe weather setbacks in recent months, while America's hard red winter wheat seedlings have also suffered from a lack of rain and snow.
Macquarie on Tuesday cautioned of a "serious risk of damage" to the US hard red winter crop from temperatures which are expected once again to fall below the -10 degrees Fahrenheit deemed a danger level by Kansas State University.
Last week, Barclays Capital warned that a "significant" drop in Chinese wheat production "could propel international prices strongly higher".
However, while Chicago's benchmark March wheat contract showed some recovery following the FAO alert, it remained in negative territory as of 14:00 GMT, down 0.7% at $8.53 a bushel

Continue reading this article >>

Commodities will offer rich rewards for courageous investors

by Robin Bromby

"Think long term" is one of those eternal pieces of advice to investors. Remember it as the year progresses.

There may be some corrections, and possibly nasty ones. And it may not always make sense.

Take the outbreak of the crisis in Egypt. In the days before, metals came off substantially and gold looked like it was going to experience the 20 per cent correction some analysts had been predicting. Then there were the riots on the streets of Cairo and suddenly gold was on the way up again and the entire base metals complex rose.

But then, just to make it more confusing, gold fell in the next trading session as investors switched to the US dollar as an alternative safe haven -- even though at that stage it looked as if Egypt might fall under the control of Muslim fundamentalists.

Yet, at the same time and against a slightly stronger greenback, copper and tin that same night recorded new highs of $US9782 a tonne and $US30,240 a tonne respectively.

But those rises were driven more by improving economic news out of the US and continuing optimism about the Chinese economy than by the North African situation. Confusing, isn't it?

Oil, of course, hit its highest point since October 2008, even though Egypt is not an oil producer; it was more the Suez Canal factor -- although, as we shall see, the real oil game is China's rising imports of the black gold.

You see why the clear head will be necessary? And those dry hands and nerves will come into play if anything does go bump in the night in the Chinese economy. Pray for the property sector there, is the only advice available at this stage.

At the start of what could be an interesting year, two main factors are influencing the way commodities shape up. One is the global geopolitical situation.

There's nothing new in the way the markets reacted to the Egyptian crisis. Investors in troubled times will always race to hard assets.

Back in 1861, during the American Civil War, a US naval vessel had stopped a British vessel and removed two Confederate emissaries on their way to London. Washington waited for the reaction from London.

When the British newspapers arrived in New York, they reported that Britain, because of the outrage over the affront to its sovereignty, was sending troops to Canada and there was the possibility of a declaration of war against the northern states, this at a time when the war against the Confederacy was going badly. When the market reopened the next morning, there was panic on the floor of the New York Stock Exchange as bonds were dumped and investors rushed into commodities, the then favourites being gold, saltpetre (an ingredient of gunpowder) and gunpowder itself.

The other factor is the supply-demand relationship. There is expected to be a deficit of about 500,000 tonnes of copper this year. Tin's price has been propelled almost entirely by the looming shortages, caused partly by problems with Indonesia's output.

Global steel production hit a new record last year. The World Steel Association has released figures that show output was 1.41 billion tonnes against 1.23bn tonnes the year before. This surprisingly robust increase was better than had been expected.

In fact, that's something you hear a lot from analysts these days. Everyone has, indeed, been impressed by the speed and strength of the bounce-back after the global financial crisis. Stimulus packages seem to have worked.
The result of the steel production growth is that it has a ripple effect.

Suddenly, iron ore supplies are tight; similarly with coking coal, exacerbated by the Queensland floods. Then there are all the other metals that go into steel products, including molybdenum, niobium, manganese and tungsten. No wonder prices are rising across the board. But no market runs up in a straight line indefinitely. Corrections and pullbacks are all part of the game. That's where the long-term picture comes into play.

By the end of January, we had seen five back-to-back months of gains in commodity prices, the longest winning streak since early 2000. The Thomson Reuters/Jefferies CRB Index -- the one that matters when charting commodity prices -- was at its highest point since October 2008. The main propellants were copper, cotton and hogs, although cocoa hit a 30-year high. China beat growth forecasts and the US economy got a touch of colour back in its cheeks.

But you can stare at charts and indices all day, yet there's a certain seat-of-the-pants element to investing in commodities.

You just have to look around you; the trend is your friend if you have commodity positions. China and India are industrialising and new cities are being built. All those apartments need stainless steel (nickel), tiles (zircon) and wiring (copper), and their occupants will want to run wide-screen television sets (a range of commodities, including rare earths) and airconditioning in the summer (thermal coal and uranium to provide the electricity).

China has already mined most of the high-grade deposits of most minerals, and is working out lower-grade mines. Beijing's solution is to put its foot on as much high-grade material as it can around the world and then blend imports with domestic supplies to eke out its own resource base.

South Korea is establishing a strategic reserve of certain metals. It doesn't want to be left out as the squeeze on supply gets inevitably tighter.

Then there's the issue of hard assets versus paper money.

Jim Rogers, former partner of George Soros and now routinely described as a "legendary investor", doesn't worry about corrections in gold, copper, oil and other commodities. He has not wavered in recent years in terms of his bullishness when it comes to commodities.

There hasn't been what he calls "a major elephant oilfield discovery" in more than 40 years. What, he asks, does that tell you about the oil price?
If you put money into the stockmarket, put it into commodity stocks, is his advice.

"If the world economy gets better, commodities are going to make a fortune. If the world economy does not get better, commodities are the place to be because they're gonna print more money. This is the time when you should own real assets, not stocks and bonds," he adds.

But, even so, the real picture out there tells the story.

Last year China's imports rose above 100 million tonnes of thermal coal and 10 million barrels of oil a day for the first time. It's hard to be a bear with those sorts of figures.

Continue reading this article >>

Copper prices expected to rise to new highs

By May Wong

Copper prices are scaling new highs this year. On Monday, they surged to a record US$10,160 a tonne.

And although prices fell by about 1 per cent in London on Tuesday after China raised interest rates, some analysts expect the base metal to hit the US$11,000 per tonne mark by December this year.

Major infrastructure projects in countries such as China and Brazil are key drivers for increased copper demand. And analysts say demand is not about to ease any time soon.

Yingxi Yu, VP, Commodities Research, Barclays Capital, said: "Copper stands out from the other base metals in a sense that the supply side is most constrained. The supply side has been lagging behind demand growth for a very long time.

"And we do not see any reason to turn much more optimistic on the mines supply of copper anytime soon.

"China has been in the driving seat of base metal demand for a very long time now and it's still growing at a double-digit pace. We estimate that Chinese copper demand grew by about 15 per cent last year. It will slow to seven per cent in 2011, but it's still a huge amount in tonnage terms."

China remains the world's largest copper consumer, accounting for about 40 per cent of the market.

Analysts point out that any price correction from current levels will be healthy but short-lived.

Ong Yi Ling, investment analyst, Investment Department, Phillip Futures, said:
"We don't discount the possibility that there could be a shorter term correction in copper prices in the event that China chooses to enforce aggressive tightening measures to combat inflation.

"But on a longer term basis, we see that Chinese demand for copper may continue to surprise from the upside. And the copper market could be in a deficit in 2011 - so that in itself could be supportive of prices to head towards the US$11,000 tonne level mark."

With such a promising outlook for copper, some observers say this could attract more investors.

With copper Exchange-Traded Funds, this could also drive up investor interest, as they make it easier for an average investor to take a position in copper.

Continue reading this article >>

Housing Stocks Are Crashing In Latin America

by Gregory White

Right now Latin America, and Brazil in particular, is experiencing a sharp selloff in its real estate market. Latin American real estate stock returns have dived since the start of 2011, down over 12%, according to Citi Analysts.
Brazil is getting trounced. Homebuilder stocks in the country have sank an average of 15%, year-to-date, according to Goldman Sachs.

The reason behind the sharp drop in homebuilder equity prices is that Brazil is in the midst of a round of tightening measures to combat inflation.

Some are now worried that those tightening measures will spill over into the mortgage market, limiting demand for new houses, and sending prices lower.

But, Goldman Sachs don't see Brazilian tightening measures having this impact. Instead, they see this is an opportunity for investors to get in on the Brazilian story.

Nevertheless, housing demand is more than 3X what companies can build today, and should continue to outpace supply in the coming years, as it takes time for companies to build capacity. We expect real wages to grow 3% in 2011E, as unemployment remains low. Private banks are stepping up real-estate lending and increasing competition could lead banks to reduce mortgage rates, which are not tied to the benchmark Selic rate. Also, we do not expect macro-prudential measures towards slowing down real-estate loans.

While investors might immediately figure credit contraction is going to lead to a housing downturn, it appears there are several reasons why Brazil may escape this scenario.

Everything You Need To Know About Cotton In Two Simple Pie Charts

Joe Weisenthal

Cotton, like several other commodities, has been on a tear.
Here are the two key charts showing where the cotton comes from, and who uses it, courtesy of Jefferies:
Image: Jefferies
Image: Jefferies
Meanwhile, the good news is that because we use so little of it domestically -- thanks to the end of US textile manufacturing -- we're a HUGE cotton exporter.
Image: Jefferies

Continue reading this article >>

Corn growers' profits to top $200 an acre

by Agrimoney.com

America's corn farmers are, for a second successive year, to reap profits of more than $200 an acre, creating fertile ground for shares in nutrient groups, Credit Suisse has said.
The bank, in a note foreseeing "limited downside risk" to shares in fertilizer groups, pegged corn farmers out-earning peers in soybeans and wheat this year, with a profit of more than $205 an acre.
The estimate - which comes as US growers are weighing up options for spring sowings, a process widely expected to favour increased corn area – would put profits in line with last year's $206.70 per acre, a figure huge by historical estimates.
In 2008, the best year of the last rally in grain prices, profits reached $101.10 an acre, with corn famers suffering at least nine years in the red in a losing streak which ended in 2006.
Corn growers' losses from 1997 to 2005 totalled $678m on Credit Suisse estimates, which for this year factor in December futures prices.

'Bullish price environment' 
Grower profitability is being helped by a lag in the recovery markets behind that in farm commodities.
Prices of potash, for instance, are still 45% behind average levels for 2008, while those for soybeans are 16% ahead, and for corn up 20%.
However, with phosphate prices back on their way above $500 a tonne this year, and potash hitting that level in 2012, including freight, on Credit Suisse estimates, the "bullish price environment should support" sector shares.
The bank lifted its price target on shares in Russia's Uralkali from $40 per depositary receipt to $46, and on stock in Israel Chemicals to 68.40 shekels from 54.50 shekels.

Acron divergence 
For Uralkali, which revealed on Monday it had received investor approval for a merger with domestic peer Silvinit, the upgrade represented a second boost, after UralSib analysts upgraded its target price on the depositary receipts to $50 from $42, also citing higher potash prices.
"Uralkali's position is strengthened by its being one of the lowest cost potash producers globally," UralSib analyst Anna Kupriyanova said.
However, the brokers differed on prospects for Acron, the Russian nitrogen group, which Credit Suisse downgraded to "neutral" from "outperform", citing the higher prices the group looked set to pay for potash.
Ms Kupriyanova lifted her rating on Acros shares to "buy" from "hold", citing the group's 8.1% stake in Silvinit, which had been made more liquid by the Uralkali deal, and, if sold, could provide funds to launch its own potash projects

Continue reading this article >>

Silver to hit $42 in 2011

by Commodity Online

 Where is silver price heading? What will be the average silver price in 2011? Bullion investors have been predicting the possible price of silver between the range of $30-$50 for the year 2011.

A new forecast on silver from precious metals analyst Mark Thomas says that the white metal price will hit $42 in 2011.

Thomas’ prediction published in the Silver Shortage Report says that silver price will touch a $42 target by the end of 2011, which would be an approximate 40% gain for the year.

“Our 2012 price target is $65, which would be an additional 55% annual gain in 2012. Finally we expect the price to hit $120 by the end of 2013 for an additional 85% annual gain. That would mean the price would go from approximately under $30 recently to $120 over the next three years for a potential staggering 300% plus gain. Do we have a crystal ball and know this for sure, of course not! We also do not try to predict the price trend tomorrow, next week, next month or over the next three to six months. However, the evidence to us says that over the next one, two and three years our price predictions are not only possible but very probable,” says the report.

It further states: "Since the total world Silver market is probably less than $35 billion, it trades more like a smaller cap stock compared to the gold market which is more like a large cap blue chip stock. It is very volatile, whipped back and forth by money flow in or out and because it relies on the futures market so heavily, it can easily be manipulated."

According to Thomas, there is a developing supply/demand imbalance situation in the physical silver market.

“While that situation has been already been occurring somewhat for years, we believe in the next three years it will manifest itself more prominently in the upward price of silver,’ he points out.

“We believe the true degree of the imbalance has only recently started to be reflected by a rising silver price. We also believe that Silver has just begun a significant multi-year move higher. We think the potential subsequent investment gains will be so significant, that it is the single best investment opportunity currently in both financial (stocks and bonds) and all commodity asset classes (not just precious metals),” Thomas adds.

Thomas says he believes in this thesis so strongly that he has moved 80% of his family's investable assets into a silver exchange traded fund and the remaining 20% in one silver mining stock.

Continue reading this article >>


by John Mauldin

Today’s OTB features an excerpt from my friend Vitaliy Katsenelson’s recently published The Little Book of Sideways Markets. Vitaliy is CIO at Investment Management Associates, a value investment firm in Denver, and he is a prolific and engaging writer (you can find and subscribe to his articles at http://ContrarianEdge.com). I had the pleasure of writing the foreword to Vitaliy’s book, and here is a brief excerpt:

“Markets go from long periods of appreciation to long periods of stagnation. These cycles last on average 17 years. If you bought an index in the United States in 1966, it was 1982 before you saw a new high – that was the last secular sideways market in the United States (until the current one). Investing in that market was difficult, to say the least. But buying in the beginning of the next secular bull market in 1982 and holding until 1999 saw an almost 13 times return. Investing was simple, and the rising markets made geniuses out of many investors and investment professionals.
“Since early 2000, markets in much of the developed world have basically been down to flat. Once again, we are in a difficult period. Genius is in short supply.

” ‘But why?’ I am often asked. Why don’t markets just continue to go up, as so many pundits say that “over the long term” they do? I agree that over the very long term markets do go up. And therein is the problem: Most people are not in the market for that long – 40 to 90 years. Maybe it’s the human desire to live forever that has many focused on that super-long-term market performance that looks so good.

“In the meantime, we are in a market environment where investors have to be more actively engaged in their investments than before during a bull market when the rising tide lifted all ships. The Little Book of Sideways Markets is a life preserver that will help you navigate these perilous waters. Wear it well and wisely.”

In the excerpt that follows, Vitaliy explains the whys and wherefores of bull, bear, and sideways markets.

John Mauldin, Editor
Outside the Box

A Sideways View of the World
by Vitaliy Katsenelson

What Happens in a Sideways Market

MOST PEOPLE (MYSELF INCLUDED) find discussions about stock markets a bit esoteric; for us, it is a lot easier to relate to individual stocks. Since a stock market is just a collection of individual stocks, let’s take a look at a very typical sideways stock first: Wal-Mart. It will give us insight into what takes place in a sideways market (see Exhibit 2.1).

Exhibit 2.1 Wal-Mart, Typical Sideways Market Stock
Though its shareholders experienced plenty of volatility over the past 10 years, the stock has gone nowhere – it fell prey to a cowardly lion. Over the last decade Wal-Mart’s earnings almost tripled from $1.25 per share to $3.42, growing at an impressive rate of 11.8 percent a year. This doesn’t look like a stagnant, failing company; in fact, it’s quite an impressive performance for a company whose sales are approaching half a trillion dollars. However, its stock chart led you to believe otherwise. The culprit responsible for this unexciting performance was valuation – the P/E – which declined from 45 to 13.7, or about 12.4 percent a year. The stock has not gone anywhere, as all the benefits from earnings growth were canceled out by a declining P/E. Even though revenues more than doubled and earnings almost tripled, all of the return for shareholders of this terrific company came from dividends, which did not amount to much.

This is exactly what we see in the broader stock market, which is comprised of a large number of companies whose stock prices have gone and will go nowhere in a sideways market.

Let’s zero in on the last sideways market the United States saw, from 1966 to 1982. Earnings grew about 6.6 percent a year, while P/Es declined 4.2 percent; thus stock prices went up roughly 2.2 percent a year. As you can see in Exhibit 2.2, a secular sideways market is full of little (cyclical) bull and bear markets. The 1966–1982 market had five cyclical bull and five cyclical bear markets.

This is what happens in sideways markets: Two forces work against each other. The benefits of earnings growth are wiped out by P/E compression (the staple of sideways markets); stocks don’t go anywhere for a long time, with plenty of (cyclical) volatility, while you patiently collect your dividends, which are meager in today’s environment.
A quick glimpse at the current sideways market shows a similar picture: P/Es declined from 30 to 19, a rate of 4.6 percent a year, while earnings grew 2.4 percent. This explains why we are now pretty much where we were in 2000.

Bulls, Bears, and Cowardly Lions – Oh My 

Exhibit 2.3 describes economic conditions and starting P/Es required for each market cycle. Historically, earnings growth, though it fluctuated in the short term, was very similar to the growth of the economy (GDP), averaging about 5 percent a year. If the market’s P/E did not change and always remained at its average of 15, then we would not have bull or sideways market cycles – we’ d have no secular market cycles, period! Stock prices would go up with earnings growth, which would fluctuate due to normal economic cyclicality but would average about 5 percent, and investors would collect an additional approximately 4 percent in dividends. That is what would happen in a utopian world where people are completely rational and unemotional. But as Yoda might have put it, the utopian world is not, and people rational are not.

Exhibit 2.3 Economic Growth + Starting P/E =
The P/E journey from one extreme to the other is completely responsible for sideways and bull markets: P/E ascent from low to high causes bull markets, and P/E descent from high to low is responsible for the roller-coaster ride of sideways markets.

Bear markets happened when you had two conditions in place, a high starting P/E and prolonged economic distress; together they are a lethal combination. High P/Es reflect high investor expectations for the economy. Economic blues such as runaway inflation, severe deflation, declining or stagnating earnings, or a combination of these things sour these high expectations. Instead of an above-average economy, investors wake up to an economy that is below average. Presto, a bear market has started.

Let’s examine the only secular bear market in the twentieth century in the United States: the period of the Great Depression. P/Es declined from 19 to 9, at a rate of about 12.5 percent a year, and earnings growth was not there to soften the blow, since earnings declined 28.1 percent a year. Thus stock prices declined by 37.5 percent a year!

Ironically – and this really tells you how subjective is this whole “science” that we call investing – the stock market decline from 1929 to 1932 doesn’t fit into a “secular” definition, since it lasted less than five years. Traditional, by-the-book, secular markets should last longer than five years. I still put the Great Depression into the secular category, as it changed investor psyches for generations. Also, it was a very significant event: stocks declined almost 90 percent, and 80 years later we are still talking about it.

However, a true, by-the-book, long-term bear market took place in Japan (take a look at the next chart). Starting in the late 1980s, over a 14-year period, Japanese stocks declined 8.2 percent a year. This decline was driven by a complete collapse of both earnings – which declined 5.3 percent a year – and P/Es, which declined 3 percent a year. Japanese stocks were in a bear market because stocks were expensive, and earnings declined over a long period of time. In bear markets both P/Es and earnings decline.
In sideways markets P/E ratios decline. They say that payback is a bitch, and that is what sideways markets are all about: investors pay back in declining P/Es for the excess returns of the preceding bull market.

Let’s move to a slightly cheerier subject: the bull market. We see a great example of a secular bull market in the 1982–2000 period. Earnings grew about 6.5 percent a year and P/Es rose from very low levels of around 10 to the unprecedented level of 30, adding another 7.7 percent to earnings growth. Add up the positive numbers and you get super-juicy compounded stock returns of 14.7 percent a year. Sprinkle dividends on top and you have incredible returns of 18.2 percent over almost two decades. No surprise that the stock market became everyone’s favorite pastime in the late 1990s.

The Price of Humanity

Is 100 years of data enough to arrive at any kind of meaningful conclusion about the nature of markets? Academics would argue that we’d need thousands of years’ worth of stock market data to come to a statistically significant conclusion. They would be right, but we don’t have that luxury. I am not making an argument that sideways markets follow bull markets based on statistical significance; I simply don’t have enough data for that.

Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble . . . to give way to hope, fear and greed.

–Benjamin Graham
As the saying goes, the more things change the more they remain the same. Whether a trade is submitted by telegram, as was done at the turn of the twentieth century, or through the screen of an online broker, as is the case today, it still has a human originating it. And all humans come with standard emotional equipment that is, to some degree, predictable. Over the years we’ve become more educated, with access to fancier, faster, and better financial tools. A myriad of information is accessible at our fingertips, with speed and abundance that just a decade ago was available to only a privileged few.

Despite all that, we are no less human than we were 10, 50, or 100 years ago. We behave like humans, no matter how sophisticated we become. Unless we completely delegate all our investment decision making to computers, markets will still be impacted by human emotions.

The following example highlights the psychology of bull and cowardly lion markets:

During a bull market stock prices go up because earnings grow and P/Es rise. So in the absence of P/E change, stocks would go up by, let’s say, 5 percent a year due to earnings growth. But remember, in the beginning stages of a bull market P/Es are depressed, thus the first phase of P/E increase is normalization, a journey towards the mean; and as P/Es rise they juice up stock returns by, we’ll say, 7 percent a year. So stocks prices go up 12 percent (5 percent due to earnings growth and 7 percent due to P/E increase), and that is without counting returns from dividends. After a while investors become accustomed to their stocks rising 12 percent a year. At some point, though, the P/E crosses the mean mark, and the second phase kicks in: the P/E heads towards the stars. A new paradigm is born: 12-percent price appreciation is the “new average,” and the phrase “this time is different” is heard across the land.

Fifty or 100 years ago, “new average” returns were justified by the advancements of railroads, electricity, telephones, or efficient manufacturing. Investors mistakenly attributed high stock market returns that came from expanding P/Es to the economy, which despite all the advancements did not turn into a super – fast grower.

In the late 1990s, during the later stages of the 1982–2000 bull market, similar observations were made, except the names of the game changers were now just-in-time inventory, telecommunications, and the Internet. However, it is rarely different, and never different when P/E increase is the single source of the supersized returns. P/Es rose and went through the average (of 15) and far beyond. Everybody had to own stocks. Expectations were that the “new average” would persist – 12 percent a year became your birthright rate of return.

P/Es can shoot for the stars, but they never reach them. In the late stage of a secular bull market P/Es stop rising. Investors receive “only” a return of 5 percent from earnings growth – and they are disappointed. The love affair with stocks is not over, but they start diversifying into other asset classes that recently provided better returns (real estate, bonds, commodities, gold, etc.).
Suddenly, stocks are not rising 12 percent a year, not even 5 percent, but closer to zero – P/E decline is wiping out any benefits from earnings growth of 5 percent and the “lost decade” (or two) of a sideways market has begun.

This Time Is Not Different

I’ve done a few dozen presentations on the sideways markets since 2007. I’ve found that people are either very happy or extremely unhappy with this sideways market argument. The different emotional responses had nothing to do with how I dressed, but they correlated with the stock-market cycle we were in at the time of the presentation.

In 2007, when everyone thought we were in a new leg of the 1982 bull market, I was glad that eggs were not served while I presented my sideways thesis, for surely they would have been thrown at me. In late 2008 and early 2009, my sideways market message was a ray of sunlight in comparison to the Great Depression II mood of the audience.

Every cyclical bull market is perceived as the beginning of the next secular bull market, while every cyclical bear market is met with fear that the next Great Depression is upon us. Over time stocks become incredibly cheap again and their dividend yields finally become attractive. The sideways market ends, and a bull market ensues.

Where You Stand Will Determine How Long You Stand 

The stock market seems to suffer from some sort of multiple personality disorder. One personality is in a chronic state of extreme happiness, and the other suffers from severe depression. Rarely do the two come to the surface at once. Usually one dominates the other for long periods of time. Over time, these personalities cancel each other out, so on average the stock market is a rational fellow. But rarely does the stock market behave in an average manner.

Among the most important concepts in investing is mean reversion, and unfortunately it is often misunderstood. The mean is the average of a series of low and high numbers – fairly simple stuff. The confusion arises in the application of reversion to the mean concept. Investors often assume that when mean reversion takes place the figures in question settle at the mean, but it just ain’t so.

Although P/Es may settle at the mean, that is not what the concept of mean reversion implies; rather, it suggests tendency (direction) of a movement towards the mean. Add human emotion into the mix and P/Es turn into a pendulum – swinging from one extreme to the other (just as investors’ emotions do) while spending very little time in the center. Thus, it is rational to expect that a period of above-average P/Es should be followed by a period of below-average P/Es and vice versa.

Since 1900, the S&P 500 traded on average at about 15 times earnings. But it spent only a quarter of the time between P/Es of 13 and 17 – the “mean zone,” two points above and below average. In the majority of cases the market reached its fair valuation only in passing from one irrational extreme to the other.

Mean reversion is the Rodney Dangerfield of investing: it gets no respect. Mean reversion is as important to investing as the law of gravity is to physics. As long as humans come equipped with the standard emotional equipment package, market cycles will persist and the pendulum will continue to swing from one extreme to the other.

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by Cullen Roche

1)  Is the high yield market now sending a warning? One of the most striking characteristics of the rally over the last two years has been the divergences between the high yield bond market and the S&P 500.  During the early portion of the rally the high yield market lagged substantially.  To me, it was one of many signs that said credit markets were still the more attractive value, however, as the rally progressed the HY market matched the performance of equities.  The divergence became apparent again following the flash crash when HY bonds failed to match the fear that equity markets were displaying.  In recent months equities have surged ahead for the first time since the rally began in March 2009.  While there is little to feel bearish about right now I wonder if this isn’t a sign that a more cautious stance on the markets isn’t warranted?
2) Bring on the bubbles. This market feels more and more like it has all the ingredients to get very bubbly in the coming years.  A bubble needs three criteria in order to form:
  • Fundamental factors that generate a rational market response.
  • A trigger mechanism that transforms a rational market into an irrational market.
  • The psychological acceptance of irrational pricing that distorts fundamentals from reality.
The combination of good profit growth, decent economic growth, surging commodities, the Bernanke put and the acceptance that the Fed will not allow equity price declines have all come together to create a perfect environment for irrational exuberance to become pronounced. If the Fed has it their way we could easily surpass Goldman’s 1500 target on the S&P before they are even done with QE2.  And who knows where commodity prices will be at that stage….

3) Capitalism without losers. Just how damaging is a world without losers?  Yesterday’s consumer credit data made it pretty clear that the consumer is starting to re-leverage.  This is extremely positive for economic growth in the near-term, however, it is alarming in the long-term.  Consumers haven’t actually straightened out their balance sheets, but why should they?  No one loses in this market.  There are no repercussions for excessive debt and out of control spending.  So the lesson to consumers is obvious – you don’t need to be prudent.  You don’t need to save.  You need to borrow.  You need to leverage yourself up.  After all, you are American.  You have a right to own an Ipad, a flat screen TV, a luxury automobile, a McMansion and all of the other things that are not privileges, but our rights as Americans.  And we know this is true because it is what the government promotes via their endless “no losers” capitalism policy.

This government’s policies are directly tied around the idea of getting credit going again.  After all, it is the core of the theories that have driven economic policy for decades now.  For the last 30 years we have focused on building a banking behemoth that specializes in bankrupting its clientele. We have de-regulated the banking sector to the point where they have a virtual monopoly on the US economy and without them we think we can no longer survive.  We are so dependent on credit growth that we have all mortgaged our futures away just to keep this economy afloat and the music playing for one more decade.

We reward those who buy homes when they are overvalued.  We encourage speculation in markets when the fundamentals aren’t there to support them.  We pay people for sitting at home and doing nothing.  We bailout companies that made bad bets.  We reward people for buying cars they can’t afford.  And worst of all, we don’t even prosecute the people who helped cause the recent credit crisis.  Oh, capitalism without losers.

The scariest part of this is my own mentality.  I find my mind wandering sometimes thinking about what it would be like to be totally reckless with my spending.  Oh the things I could buy if I just leveraged myself to the hilt.  I could really help get this economy going again.  Add a little velocity to the money supply while crippling my own balance sheet and helping a bank to pad its own capital base just in case it decides to pay its executives a little extra this year.  That’s what they want after all, right?  Sadly, I am an outlier in the world of credit.  I have been one of those prudent savers who now feels punished.  But here I am learning that prudence is for losers.  And if a pragmatist like myself is having these thoughts then what sort of thoughts are the irrational having?  And where will this take us?  Surely, it can’t be good.  We are promoting a reckless approach to savings and investment.  It feels great for now much like it did during the earlier portion of this decade, but I fear for its repercussions and how this damaging psychological approach to markets will ultimately play out.  I fear we will look back at some point in the not so distant future and wonder why we allowed this to happen to ourselves and why we continue to push theories and economic strategy that failed us long ago….

15 reasons to own Silver

By Mark Thomas

1. The US Dollar has lost 20% of its purchasing power just since 2000 and 30% since 1990. 70% of that decline has been since 1978 when the mandate for the Fed was changed to a dual mandate of both price stability and full employment. Since the Federal Reserve was created in 1913, the US dollar has lost 95% of its purchasing power. When you compare the appreciation in precious metals to the dollar in those same time frames, those facts alone should convince you that you need significant exposure to the sector protect your wealth.

2. Central banks for decades have been selling off their reserves of silver to meet excess demand which has kept prices artificially low. That has made mining unprofitable for so long there is a deficit of annually mined silver at today’s prices.

3. Since 1980 the above ground available gold stores have increased 600% while above ground available silver stores have been reduced 90% during the same time frame.

4. The Silver Exchange Traded Funds have democratized precious metals investing to the average investor who know doesn’t have to worry about delivery and storage. This increase in demand from new investors is removing almost 25% of current production annually. That is a positive as long as investors continue adding to their holdings. Surprisingly Silver investors even during the panic of 2008 amidst a 50% decline in the price of silver actually added to their positions.

5. A significant silver mine needs multi millions of dollars (in some cases hundreds of millions) to get started, could take three to five years before any production has begun.

6. In a precious metals bull market, silver consistently over the long-term outperforms gold. Since October 2001, silver has increased in price from approximately $4 to a recent high of $31 which is an approximate 775% gain. During that same approximate time period, Gold went from $265 to a recent high of $1430 for an approximate gain of 540%. So Silver outperformed Gold by 235% in the same time period.

7. This time participation by investors will be global! In 1980 only investors from North America, Europe and the Middle East were involved in big precious metals bull market. Now there are hundreds of millions of new potential investors in the same countries but most importantly in China, India and the former Soviet Union. This Bull market will be global in nature which will make it that much more explosive to the upside.

8. Silver is the more attractive to average investors when gold prices are more than $1000 per ounce.

9. China which is a significant producer of silver and used to export a significant percentage of their production. They have now significantly limited exports by 40%.

10. It is believed that China is purchasing and storing large quantities of both gold and silver. China’s objective is to make their currency the new reserve country for the world, so they can diversify out of the consistently declining US dollar.

11. China’s Premier just called the US dollar as a world reserve currency “a product of the past” so their goal is pretty clear to anyone listening.

12. To make the Chinese currency different from all other fiat currencies it will be backed by a reserve of gold and silver.

13. Deregulation in financial markets and the eternal ethic of greed by Wall Street and major money center banks are destroying the fabric and the functioning of the United States economy, its workers, savers and the country itself.

14. When economies of major societies use fiat money that is backed by nothing precious metals approximately every forty years do an accounting and rise in price to equal all the paper money every created and the debts incurred.

15. Precious metals will be the fifth and final asset bubble in the next three to five years. First were the internet and technology stock market bubble, then real estate, then an overall world wide credit bubble, then the US Treasury market. Finally a lack of confidence in the currency and solvency will lead to the most spectacular transfer of wealth yet with an explosive bubble in precious metals prices.

Expect a commodities market splinter in 2011

By Ryan Cole

We're about to see the commodities market splinter... make sure you're holding the right piece. It's difficult to say what will happen with the overall commodities market in the new year. There's just too many factors affecting it. Anyone who speaks with absolute certainty about that market is a fool, or lying.

That said, it's easier to look at a piece of the commodities market -- metals, specifically -- to see what's happening and what we can expect in the coming months: a commodities market splinter.

Let me explain...

Given the uncertainty surrounding the world economy, things look fairly solid for precious metals. With every currency looking weak right now, gold and silver should continue to do quite nicely.

In fact, it's difficult to imagine what the world could do over the next year to knock precious metals down. As long as there's uncertainty in economies and/or currencies, precious metals will do well.

Not All Good News for Metals

Industrial commodities, however, will be more at the mercy of the market. If China's interest rate hike does manage to cool its economy, then copper, steel, coal and oil all could fall back a bit.

If, however, the US recovery continues to outpace predictions, and Europe finds its footing, that should more than make up for an easing of demand in the middle kingdom.

Frankly, they could go any direction. And that's true of most industrial commodities... but not all of them.

Green Energy Comes of Age

You've heard it forever -- but this time it's true.

It's time to look at renewable energy. What makes this time different?

Well, for starters, two car companies are putting electric cars into full production -- the Chevy Volt and the Nissan Leaf. A plethora of others aren't far behind, with oil sticking around $90 a barrel (and looking more likely to head up thanks to shrinking supply).

Meanwhile, there are companies building the first solar power plants that can compete -- and in some cases beat -- coal on price alone. With most companies still trying to keep costs down, yet many also holding a large war chest of cash that hasn't found good investment vehicles for years, an outlay for cost-cutting infrastructure seems like a no-brainer.

Even if the cost of oil and coal falls, there is value in knowing exactly what you'll be paying for your energy needs. With solar and other renewables, you get that -- a fixed initial outlay, followed by free energy.

The simple fact is, right now demand for renewable energy far outstrips the ability of producers to satisfy it. You have to go on waiting lists with the best solar panel companies.

Growth in renewables has been in the double digits for years. That was no big deal when they were a fraction of a percent of overall power generation. But these days they're large enough that a double-digit increase is now quite substantial.

Where to Get In on the Green

The Green Age is coming. This is your last chance to get on board before it becomes a completely mature industry.

That means investing in a special class of commodities. I'm talking about those used to make the converters and cells found in green tech and new types of batteries.

As our industries shift from coal- and oil-based to renewables over the next few decades -- with the pace increasing considerably in the short term -- we can be sure that demand for these green metals will skyrocket.

Meanwhile, supply is actually shrinking -- at least until new mines can get online, and new processing plants are built to deal with this new supply. (It takes five years to build a processing plant.)

For long-term success and large short-term gains, you want to be in this field. The opportunity could be staggering.

To help you take the first step, we just finalized a Special Report on green technology. The U.S. wants to use this technology to decrease our dependence on oil.

But China has a 98% monopoly on a natural resource that is vital to green technology... and we're about to experience a serious shortage! Learn more about what's going on... and more importantly, how you could post gains from it.

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Corn, soybeans off highs while wheat rallies

by Allendale Inc.

Corn: There was a slight surprise in corn on Monday with some selling move across most of the agricultural markets. This left many people wondering if they were wrong to buy recent dips. It is hard to believe that is the case. Trade is still looking for the carryout in corn to drop from 745 million bushels down to 736. There is nothing in that expectation to suggest selling was needed.

Even after Friday’s strong close, these prices will be well supported if the report comes out as expected. Trade is not looking for a drastic drop in stocks. Some might even say the recent estimate is on the conservative side. Crude may once again have helped the pull on corn being down over $1.50 through the second half of corn trade.

Recently, we have seen the buyers allow further pullbacks before coming back in with good support. If this carryout number does come in at trade expectations, this corn market will have the support to carry it right into the acreage battle and planting concerns. With the recent rally occurring without a single export to China and with little support from funds, it is easier to expect a slow grind higher for now.

It is always important to keep hedges prepared for a disappointing number, as the USDA can surprise us. Even though we don’t expect Wednesday’s report to throw a bearish number at us, it is always better to be prepared, especially when protecting prices this high. Remember that a carryout number left alone would still be considered by trade to be disappointing…Ryan Ettner
Soybeans: Beans closed 20 cents off the highs after being victim to profit-taking. Traders are reducing their risk ahead of Wednesday’s USDA report. We are still expecting to see tighter stocks than last month.

The trade is trying to reduce their risk appetite on beans now that the timely rains should have changed the outlook in South America. Any reduction in Argentina’s crop could be made up with increases in Brazil’s crop. The floor used to look at this story as bullish and now the situation has changed.

This doesn’t mean we are going straight down from here. We will see pullbacks but corn and wheat still should take the beans higher in the short term. Soybeans can’t lose too many acres right now and will have to keep pace. Our upside objective has been met but still could see a run to 1475…Steve Georgy

Wheat: Wheat rallied Monday as world buyers were back in the markets trying to get product bought on the small pullback in prices the past few days.

On Friday it was announced that Egypt was looking for 55,000 tonnes of U.S. hard red wheat, 60,000 tonnes of U.S. hard red spring wheat, and 55,000 tonnes of U.S. North Pacific soft white wheat. They ended up purchasing 55,000 tonnes of U.S. soft red wheat, 55,000 tonnes of the Australian wheat and 55,000 tonnes of Argentine wheat. There still are ongoing port delays in Egypt but it does not look like Egypt will face a grain shortage. This was Egypt’s first wheat purchase in about a month.

In other export news, Iraq purchased a total of 300,000 tonnes of wheat on Monday. Australia received a bulk of the sale, but the U.S. did sell 50,000 tonnes of wheat to Iraq. Algeria is seeking 50,000 tonnes of option origin wheat for May or June delivery. Turkey is also in for up to 300,000 tonnes of milling wheat. Iran is also going to the world market to make up production shortfalls due to drought.

All this aggressive buying of wheat shows that the world buyers are still in their panic buying mode. Total export sales year to date are 28% higher than the five year average as expected by the USDA. The four-week average sales pace is 65% above the five-year average, which shows how aggressive the world buyers have been the past few weeks. On the weather front, there is snow in the forecast for the plains. This will bring much needed moisture to the crop and give it a nice insulating cover to protect it from more winter kill…Jim McCormick

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by BondSquawk


How Bond Prices Fluctuate

A bond’s market price, like the price of any financial asset, represents the present value of the stream of future cash flows to the bondholder.

A dollar in your hand today is worth more than a dollar that you receive a year from now due to several factors:

You can deposit that money at a bank

Purchase an investment that will yield you a return for the next year.  The present value is discounted by the rate of return you could earn on that dollar over the next year (the discount rate).  Our example represents a one-time future payment, but the concept is the same for bonds that represent a stream of future payments.  The discount rate for a bond is its yield.

The price of a bond is a function of the coupon of the bond relative to the market yield of equivalent bonds.  For example, a bond with a coupon rate of 5% will be priced at par if the market yield is also 5%, if the market yield is below 5%, the bond will trade at a premium, and if the market yield is above 5% the bond will trade at a discount.  Since bond prices fluctuate with changes in market yields or the general level of interest rates, in order to determine the factors that influence bond prices we need to understand what factors influence the general level of interest rates.


What Determines the Level of Interest Rates?

Because treasuries have no default risk, they represent the risk-free rate of return (though treasury bonds are subject to other risks such as interest rate and reinvestment risk).  Treasury yields have three components:
  1. The risk-free real yield
  2. The inflation premium that reflects the expected rate of inflation
  3. The volatility premium that represents the risk associated with the price sensitivity of longer maturity bonds to changes in interest rates
Non-treasury bonds have a fourth component, the credit risk premium, which we will cover in another lesson.   Because treasury TIPS are indexed to inflation, their yield gives an indication of the risk-free yield.

There are a few factors that affect the price of treasuries including supply and demand, general economic activity, and budget and trade surpluses or deficits.  However, the single most important factor is the general level of interest rates, and the general level of interest rates is mainly determined by the expected level of inflation.

It is obvious that if one was able to have a reliable indication of future changes in interest rates, then one could make considerable profits in the bond markets.  Fortunately, there are some very good ways to get an indication of where interest rates are going, and we will discuss these rate indicators in future lessons.


What Influences the Level of Credit Spreads?

All domestic bonds that are not treasury issues contain some amount of default or credit risk.  This risk means that these bonds must compensate the bondholder for assuming this risk by providing a yield greater than what a treasury security of the same maturity would pay.  This yield premium is known as the credit spread.  For example, if the 10-year treasury note is yielding 5% and a 10-year AAA rated corporate bond yields 5.75%, the credit spread is .75%.

The credit spread represents the market’s perceived creditworthiness of the bond issuer and will not only vary from one bond to another, but will fluctuate over time for the same bond.  The credit spread is calculated based on the current on-the-run treasury.

The primary determinant of a bond’s credit spread is the bond’s credit rating.  However, not all bonds of the same credit rating and maturity will trade with the same credit spread.  Factors that can cause an issue’s credit spread to be larger/smaller than the credit spread of other issues of the same credit rating include:
  • A negative/positive outlook for the issuer’s industry group
  • A competitive disadvantage/advantage for the issuer
  • Expectations of a ratings downgrade/upgrade
  • A deteriorating/improving business or financial trend for an industry or issuer
  • An issue with less/more relative liquidity


The Yield Curve

A yield curve is a graph of the yields of closely related bonds of different maturities. The vertical axis of the graph represents the yield, and the horizontal axis represents the time to maturity. The yield curve of treasury securities is the most commonly seen yield curve in the U.S.


There are four basic yield curve shapes:

“Yield Curves” The Upward Sloping Curve

“Yield Curves” The Inverted Yield Curve

“Yield Curves” The Humped Yield Curve

“Yield Curves” The Flat Yield Curve

The upward sloping curve is historically the norm given the normal relationship that the longer the time to maturity, the higher the yield.  An inverted yield curve occurs when interest rates are very high and expected to fall.  A flat yield curve indicates that the term to maturity has no impact on interest rates, and a humped yield curve initially rises, but then falls for longer maturities.  Inverted and flat yield curves are fairly rare.  In recent years institutional investors have had high demand for the 30-year long bond, which has raised its price to the point that it often yields less than the 20-year.  This has caused the humped curve to be the most common shape in recent years.

The shape of the yield curve changes with the business cycle and has been a good leading indicator of economic activity.  A steeply positive sloped yield curve is indicative of an economic recovery, and is often found at the end of recessions.  Its shape reflects market expectations of a significant increase in interest rates and the fact that the fed is keeping short-term rates low to aid a slumping economy recover.

Inverted curves often precede an economic downturn.  The Fed has been raising short-term rates to slow down the economy because of high inflation and the market is anticipating that interest rates will fall, so long-term rates are lower than the extremely high short-term rates.  Inverted curves have proceeded all of the last 7 recessions (although not all inverted curves have been followed by a recession).

A flat yield curve is often the result of the Fed raising short-term rates to cool an overheated economy.  Flat yield curves are rare and do not last very long when they appear.

Many bond traders use the shape of the yield curve to derive trading strategies.  Future lessons will delve into analyzing the yield curve and yield curve related trading strategies.


Repurchase Agreements (Repos) and Reverses

Repo, short for repurchase agreement (also known as RP), is a form of short-term borrowing for government securities dealers.

In a repo transaction, the dealer sells a treasury security to investors with an agreement to repurchase the security at a later date, usually the next day, and at a fixed rate of return to the investor (the repo rate).
Repos can also be done for a longer term, such as a week or a month (this is known as term repo) or a Repo can be done on open without a fixed repurchase rate.

The rate for an open repo is most often renegotiated on a daily basis.  It is effectively a short-term loan that is collateralized by a treasury security.  The investor (lender) in the transaction is entering into a reverse repurchase agreement or reverse.

Typically, the term repo is used for both repos and reverses since the terms only refer to which side of the transaction one is on.

Dealers use repos to finance their activities because treasury securities are subject to market risk (because the price fluctuates). Due to the changing price, the investor will not lend the full value of the security.  The difference between the value of the security and the amount that is borrowed is called a haircut.


The Carry Trade

The principal behind the carry trade is to borrow short to purchase a longer-term bond that will pay a higher rate than the rate of the short-term loan.

Dealers finance their treasury purchases by borrowing against their treasury holdings by doing repo transactions, which are essentially loans collateralized by treasuries.
The risk/reward is determined by the spread between the treasury yield and the repo rate the dealer pays.
Longer maturity bonds will trade at a greater spread because:
  • They are more price-sensitive to changes in interest rates
  • They have a longer time horizon that presents more uncertainty as to the level of interest rates.
If the Fed raises rates – a dealer could end up with a negative spread.
The two-year note is a particularly popular security for the carry trade because its yield is closely tied to the fed funds rate and it is extremely liquid.

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