Sunday, June 12, 2011

Why Gold and Silver Are Not in a Bubble

Any thoughts of a bubble in precious metals is not pertinent at this time. As long as mining stocks are not in favor then any thoughts of a bubble are not applicable in the current situation. Mining stocks should be soaring in tandem with their brothers in bullion. Such is not the case. Miners are trading far below general market valuation. In past history during a bubble, mining stocks soared to hundreds of dollars a share at the same time as bullion.

Wealth in the ground represents an open ended warrant on mining potential. Mines can grow, new ore bodies can be found, while bullion has no such potential open ended expansibility.

Gold mining stocks(GDX) are incredibly cheap at $1500 gold(GLD). Before the credit crisis in March of 2008 as gold hit $1000 an ounce, miners (GDX) hit its all time high of $55. Now three years later gold is 50% higher, yet the miners have barely been able to breakout of the $55 range. Yamana (AUY) and Kinross (KGC) Gold are two majors that have been significantly underperforming gold over the past three years and are not near their pre credit price levels in 2008. These stocks have not provided any leverage to the price of gold to their shareholders. Investors are sticking to the bullion etf's and are disinterested in the miners. This lack of interest in this sector signals we still have some way to go in this precious metals bull market.

The gold miners should be trading higher if they kept pace with the rise in the bullion. The standard deviation between miners and gold bullion has never been so great. It is at times such as these that investors can benefit from this apparent discrepancy.

Currently mining stocks have corrected because of apprehension regarding the possible exit from QE2 and growing difficulties for miners worldwide. Investors who were burned during the 2008 credit crisis are concerned about a repetition of such an occurrence and its effect on a potential counter trend rally in the U.S. dollar (UUP) and long term treasuries (TLT). Small mining companies (GDXJ) depend on a readily available line of credit. Investors fear if the flow of capital were to be shut off as had been their experience in the past, their ability to operate might be impaired.

This may represent a buying opportunity for investors in small miners(GDXJ). Miners represent assets in the ground whereas etf's such as GLD and SLV may have a built in weakness in the actual physical gold and silver they are holding. If called upon to produce the actual bullion, they might not be able to do so. This would favor mining stocks which represent actual wealth in the ground.

There may be an implicit weakness in the very nature of a strictly bullion etf. Simply put a large quantity of bullion may not be able to be produced on demand. Do not be surprised if the bullion etf's find themselves unable to meet the demands of the marketplace.

In such cases, the miners would once again come into favor as the investment vehicle of choice. At present there is a deviation between bullion and assets in the ground. Investors may be reluctant to hold paper in such a climate of fear and uncertainty. There are presently astute wealthy investors who have sold some of their bullion to purchase mining stocks.

Again note that many miners are presently languishing while bullion etf's struts across the financial stage. This anomaly may not last much longer. Presently mining stocks are going through a major firesale, while bullion commands center stage.

In the markets, it is prudent to expect the unexpected. That is why we should seize the opportunity to buy straw hats in winter. Such an opportunity may be upon us now as bullion etf's may stumble in the future.

The gold mining etf (GDX) may be making a critical turn in the low 50's as it has broken through trend support. The technical conditions are even more oversold than the reversal lows in January 2011, July 2010 and February of 2010. A move above the trendline and moving averages may turn out to be a very powerful buy signal and signal the current correction is over. Careful monitoring of the uptrend is required.

See the original article >>


This week we look at data from the Bank of International Settlements, by which (if someone does a lot of work) you can figure out how much US banks have written in credit default swaps to banks in Europe on Greek, Irish, and Portuguese debt. The details should not make you happy. I meditate on whether one should buy a house now, and then discuss “the way out” of all this mess and why we will Muddle Through. Oh, and I’ll ask you for help on yet another book project, on creating jobs. And all while trying to finish early enough to go to dinner. So let’s get started.

Is It Time to Buy a House?

The answer to that question is not simple, but let’s start with my own personal experience. I bought a home in the early ’80s in Arlington, Texas for what we thought was a fair price; but the mortgage was back-loaded, so I was not buying back much equity, just paying a lot of interest. But we had a growing family and the need for space, so we made the move. I must confess I was not the savviest loan customer 30 years ago. I am now aghast.

About eight years later we had the savings and loan crisis in Texas. Real estate became cheap, in some cases real cheap. Our family was growing again and we needed more room. One home we looked at was large and on a golf course. It had also been abandoned for a year and had some damage. The RTC (Resolution Trust Corporation) owned it (the government agency that took all the debt from the failed savings and loans). At one point, it was appraised for $810,000. The loan was (I think) about $690,000.

I had been watching friends buy apartments and loan portfolios from the RTC for a dime on the dollar. True story. The RTC would set out piles of manila folders of loans on a table. You could look the folders and then bid on them. Some of the folders had actual checks from the people who had borrowed money and were still trying to pay on cars, boats, condos, whatever. There were people who would bid the value of the actual “cash” in the folders and get the bid, as the people running the RTC were just trying to get through the mess as quickly as possible. Of course, the taxpayers made up the difference.

If you had cash, you could get apartment buildings and be on positive cash flow on day one. One friend would buy older apartments, turn them into government subsidized homes for the elderly, and get his money back within a few years. For active entrepreneurs with cash, it was a good time. If you owed money or needed money, it was very bad.

In Houston, they were auctioning off homes from the courthouse steps and people were paying for them with credit cards, they were so cheap (some 3-bedrooms went for like $6,000). The economy in Houston was imploding. The joke was,“Will the last person to leave Houston please turn out the lights?”
Anyway, we fell in love with the house in Arlington. My business had (finally!) started to do better and we could afford to “move up.” But given the real estate crash, I was still under water after eight years of making payments on my current house, by about 15% or somewhere in the mid-$20,000 range (I try to forget, as it is painful).

The home we wanted to buy was up for bid. As I said, it needed lots of work. Fire ants had eaten most of the outside wiring. There was no lawn on an almost one-acre property, as it had died the last summer from lack of water. The pool was green slime. And so on.

I put in a bid for $285,000, which was much less (maybe half) than it had cost to build, but I put down a large cash deposit with the bid and offered to take it “as is, where is.” My realtor told us we would not get it, as there were bidders who were offering as much as $50,000 more, but with some requirements. I decided to hold my ground. While this was a dream home for a country boy from a small Texas town, there were other houses going on the block regularly.

As it turned out, the next week we got a call saying the RTC had accepted the bid. When we asked why, we were told they simply did not have the time or people to oversee any “fix this”bids. Even though by a financial analysis there were better bids, it had become a matter of moving that folder off the desk, as there were roomfuls still be dealt with. And having been burned once on a mortgage, I was a lot smarter this time about interest rates and terms. (I had also been in the investment world for nine years, so had learned a few things.) About ten years later, for personal reasons, I sold the home at a nice profit, and this time had paid down the mortgage quite a bit, so I had some equity.

Since then I have leased homes or condos, and still do. I now lease because it makes sense for me, given where I am in my life. I am not sure where I’ll be in five years, or what my business will look like. The world is changing so fast. (Although I could have said that at almost any time for the last 60 years and been right.) 

Also, the home I lease is quite nice but would cost me about three times in monthly payments to buy it as to lease it. Does the lease price go up at renewal? Of course. But it is still a lifestyle and cash-flow decision.
Buying a home is a personal and lifestyle choice. The owners of the villa we are staying in here in Tuscany have five homes, all over the world. They buy homes that need a lot of work, make them spectacular, and then rent them out, which more or less covers their costs and return on capital; and then they stay in them when they want to. They get people to do the work, other people to pay for it, and they “live large.” Nice life.

Jeremy and Carol Leonard are friends from Canada who are here with us this weekend. He bought a home in Hawaii, where one of his businesses is. He got it for a lot less than it would cost to build, so he was not too worried about the price. He and his family now live there, and he commutes back to Edmonton from time to time for his other business (more on that later).

All that to say is that if you are in a place where you want to buy a home, now may be the right time to start thinking about it. The banks and government are simply overwhelmed with homes that have been repossessed, and it looks like there might be as many as 2 million more homes to come onto the market. Prices in many areas are going to continue to fall, and if you can get credit, mortgage rates are quite low.

If I were buying, I would want to meet agents or bankers who are in the “deal flow.” The anecdotal stories of people getting homes for what seem like very good prices, in this depressed market, are all over the internet. There are homes that are certainly below replacement costs in some areas (and not just in the US but in certain parts of Europe as well). While I think home prices should go somewhat lower, we are out of bubble territory. There are starting to be values in the housing market for savvy shoppers. Which of course is what help creates a bottom. Which I have been writing for many years should happen in 2012-13. So you can be patient, but if you want a home, put in a bid that will make you smile if you get it accepted. No rush. And there are certainly deals for people who can use a little leverage and buy rental property.

And I must admit, if there is another crisis in Europe and prices of vacation homes like the one I am staying in drop a lot? I might just jump in. I like owning stuff. But at the right price.

Time to Get Outraged by the Banks

Long-time readers know I continuously pound the table that credit default swaps need to be put on an exchange. The Frank-Dodd bill failed in so many ways to deal with the last crisis and prevent the next one, it is hard to start a list. But an analysis by economist Kash Mansori, at, tears apart the mind-numbing 146-page report from the Bank of International Settlements, which is just one long set of tables and data. I spent an hour with it and almost went blind. (For data masochists, it is at

Kash had to do a lot of work to come up with his tables, which show how much exposure Europe and the US have to Greece, Ireland, and Portugal. (He very politely answered some questions when I emailed him.) There is a lot of useful information buried in the data, showing us who is exposed to the risk of sovereign defaults in Europe. I have openly speculated that US banks were selling CDS to Europe but had no idea how much. Now we do.

From Kash’s blog:

“Observation #1. Default Insurance Matters.

“First, the BIS data very helpfully breaks exposures into two pieces: direct exposures, which basically means creditors who own bonds issued by one of the PIGs; and indirect exposures, which for the most part means agents who sold default insurance to creditors, primarily through credit default swaps. As summarized in the following table, it seems that approximately 30% of total potential exposures to debt from the PIGs are covered by default insurance (see the figures in red). Put another way, if one of the PIGs defaults, creditors who actually hold bonds from that country will absorb about 70% of the losses, while agents (primarily banks and insurance companies) that sold insurance against the possibility of default will have to cover the remaining 30%. That’s not a trivial amount. (All figures below are in billions of USD, as of the end of 2010.)

“Observation #2. Direct Exposure in Europe, Indirect in the US.

“The table above also hints at striking differences between how European and US creditors would be hit in the case of default by one of the PIGs. If Greece were to default, for example, approximately 94% of the direct losses would fall on European creditors, and only 5% would fall on US creditors. However, US banks and insurance companies would have to make about 56% of the default insurance payouts triggered by such an event, while European agents would make only 43% of those payouts.

“The next table illustrates this difference even more starkly. In the case of Greece and Portugal, the vast majority of the losses that would be borne by creditors in Europe would be direct losses. In fact, French and German creditors would almost certainly be substantial net recipients of default insurance payments. (That’s less clear in the case of Ireland.) Meanwhile, US financial institutions would have to make substantial net default insurance payments, which would account for between 80% and 90% of all losses borne by the US in the case of default (see the figures in red below).

“Observation #3. Similar Overall Exposures in Europe and the US.

“Finally, it’s worth noting that once you account for the substantial payouts that US agents will have to make to European creditors in the case of a default by one of the PIGs, financial institutions in the US have roughly as much to lose from default as those in France and Germany. (See the figures in blue in the table above.) The apparent eagerness of US banks and insurance companies to sell default insurance to European creditors means that they will now have to substantially share in the pain inflicted by a PIG default.

“This has some important implications. First, US and European financial institutions are likely to have very different incentives as negotiations regarding debt restructuring and reprofiling proceed. US banks and insurance companies are surely delighted with the “soft restructuring” that is currently being discussed. Such a partial default would probably not trigger default insurance payments, and so the pain would be borne almost exclusively by European institutions. On the other hand, some time soon it seems likely that European creditors will begin to prefer a “hard restructuring” that would require default insurance payouts from the US institutions that sold such insurance. Given how strikingly one-sided the net default insurance payments will be (from the US to Europe), it’s easy to imagine how that could shape future negotiations over debt relief for the PIGs.

“Second, there’s an interesting puzzle here. Why have European and American financial institutions behaved so differently when it comes to the PIGs? Specifically, why have American firms been so willing to sell default insurance to the Europeans, though they have not bought much PIG debt? And conversely, why have the Europeans systematically been so eager to buy insurance for their PIG debt, even at the very high price such insurance now commands? In essence, European firms have been betting that a PIG default will happen sooner rather than later, while US firms have been betting that default would happen later or not at all.”
If I read those tables correctly, that means US banks have sold some $120 billion of credit default swaps to European banks. Let’s think about that for a minute.

When, not if, Greece defaults, US banks are going to have to dip into capital to pay those commitments. Capital that should be available for loans to businesses but will have to be paid to European banks instead. Will it be a 100% Greek default, or only 50%? If it is a default, do you have to pay all or just the defaulted portion, and when?

Why, oh why, are banks putting American taxpayers at risk, as these too-big-to-fail banks certainly are? And make no mistake, if several major banks were to collapse, our government would need to step in. The largest banks are too big for the FDIC to handle. Now, shareholders would be wiped out this time and bond holders would face haircuts. No question. But why are investment banks allowed to mix the risk with their commercial banks?

We Need a Mulligan

I occasionally golf, more in past years than today. I am a very bad golfer. I would often negotiate in friendly games a few extra “mulligans” before we started. (A mulligan is where you get to replay the ball without taking a penalty stroke.) I was actually doing my playing partners a favor by moving the game along rather than trying to find lost balls in tall grass.

I and so many other people were all for repealing Glass-Steagall back in 1998. Sometimes we just need to admit that we make mistakes, and this was a big one. We need a national mulligan, a major do-over! We should reinstate Glass-Steagall and separate investment banking from commercial banking. Yes, I know that hurts profits and maybe makes banks less competitive, but I really don’t care. When our tax dollars are risked it is just wrong.

Further, I will bet you that bank chiefs will say they have hedged their risk on European debt. OK, I would like to know, with which counterparty? AIG? Is there another AIG looming out there, selling risk insurance? Who is paying attention?

A Congressional Investigation Is Needed

Frankly, all this needs to come out in the open. Who sold this stuff to whom and for how much, and is the risk hedged, and if so to whom? Why did someone think that betting $34 billion on the ability of Greece to pay its debts was a good idea? And are the Irish CDS sold for government debt or are they bank debt? Note that we have over $100 billion in exposure to Irish debt. Long-time readers know that I think the Irish will at some point tell the ECB to stuff it on the bank debts they assumed as taxpayers. Does this put at risk all Irish debt? It’s all in those contracts.

Maybe I am overreacting (it has happened in my life), but I simply find it outrageous that banks can risk so much with so little to lose if things go bad. Just as in the subprime debacle, they make their bonuses and salaries until the end, and the public picks up the risk. Dodd-Frank was a joke. It did not solve the real problems, and has so many unintended consequences. It should be torn up and we should start over. But first we reinstate Glass-Steagall. At a very minimum, we require that banks that want to sell credit default swaps separate that division from the rest of the bank and capitalize it separately. Investors who buy from them must know that the full capital of the bank does not stand behind the CDS. I don’t care if that cuts into profits. I just don’t want the private risk and profits to become public losses.

How We Get Out of This

A good friend of ours, Jeremy Leonard, has come over from Canada to visit us for a few days. He is (among other things) in the pump business, with an office in Hawaii and in Edmonton, Alberta, Canada. He just launched the Canadian branch 14 months ago. He has figured out a way to make a pump in Canada that is superior to the competition in the mining and the oil sands businesses. When we met last December he was up to ten employees. Now he is at 50 and growing. His staff in Hawaii has doubled from 5 to 10 over the last year. He has also figured out how to solve a major environmental problem in the oil sands region, and that business is growing nicely.

Over dinner tonight, we started talking about other businesses. Dr. Mike Roizen (of “You”books and Oprah fame) is coming to stay a few days next week, and he has started lots of businesses, creating over a hundred jobs. And my partners at Altegris and CMG have doubled their staffs in the last five years.

We get out of this conundrum because a million people like Jeremy figure out how to do something faster, cheaper, and better and then actually make it happen. They aren’t sitting around waiting for Greece to default first. If they are smart, they avoid doing something that will be affected by that, and they plough ahead.
And if government gets out of the way, or actually implements policies that help, the economy and employment eventually right themselves. Texas was a basket case 20 years ago. I was fortunate that my business did not depend on the local economy. I had many friends who suffered, who lost jobs and businesses. That’s part of the process. But you get back up and do what you have to do. You figure it out.
And when a nation of entrepreneurs, all working on their individual plans, get it all figured out, the economy is back on track.

In one sense, now is the best time to start a business if you can find the capital, because you can access quality help, get equipment cheaper, lower rents, etc. Challenges? Of course. That comes with the territory of starting a business, and they never end. If you decide to sit back and coast, the world will go on and swallow you up.

20 Policies to Implement to Create Jobs

Maybe I am thinking about employment because I just agreed to do a small book with Dr. Bill Dunkelberg, good friend and fishing buddy, who is also the chief economist of the National Federation of Independent Businesses. It will be on employment in the US and what the government should do to help create jobs. Bill and I have our ideas, but we are also going to “crowd source.”

We will ask our respective readers for their ideas. My bet is that we’ll get a lot better ideas than ones we come up with on our own. The plan is to have it done in time to hit the stores in January, before the political debates really heat up. Whether it will be 10 or 20 or 30 ideas, we don’t know. Not even sure of a title, but Wiley said they would publish it. It will be a fun project and is something I hope can contribute to the “cause” of growing our economy. I believe we have a bright future and want to make sure my kids have the same chances I had.

And now it is late and time to hit the send button. And when you see your congressperson, ask them to look at the credit default swaps debacle that is brewing.

Tuscany, Kiev, Geneva, and London

Tuscany is a slice of heaven. We have already booked the villa for three weeks next year. Next Thursday Trey and I leave to go to Kiev and meet with about 20 classmates from an executive course I did two years ago at Singularity University, who are flying in from all over the world. We will spend three days talking about our businesses and the future. Two years ago we spent nine days (12 hours a day) listening to the real industry leaders talk about where their tech was going, and it was totally worth it. They have another conference in October. If that type of thing interests you, you should do it.

Then Sunday Trey and I go to Geneva, where we meet with friends and business partners, do a speech, visit CERN on Wednesday for a private tour (in exchange for a few hours of my time) and then fly on to London. On Thursday I will be a guest host on CNBC London Squawk Boxand then do a few meetings and catch a plane back to Dallas. Whew! Then I’ll be home for a while.

One of the delights of having 1,000,000 closest friends read your letter is that you get to meet them from time to time. Simone Pallessi hosted us Wednesday night at a fabulous resort 20 minutes from here, put together by one of the members of the Ferragamo family. 4,500 acres, a large winery, some of the finest villas and apartment/suites/rooms, and an unbelievable golf course, all built on a 900-year-old estate with the castle tower still standing. Simone runs the place and was a very gracious host. The Brunello they make is

And yesterday as I was outside writing, I saw a gentleman come up to the back gate (on the road) and ask if I was John Mauldin. I said yes. Story is that last night he was driving with his wife, saw the name Trequanda, remembered Il Conte Matto, and decided to change his plans. He later got a room and came by to say thanks for the recommendation and ask me to sign my book. Turns out he owns a car dealership in California. And since he brought wine, how could I say no? Life’s little pleasures.

Time to go now, as I have guests and had to finish this after we came back from dinner. Have a great week. I am behind on my rather ambitious plans to get things done while here, but I am enjoying life. And you should too!
Your watching time pass so quickly analyst,


By Erik Swartz

Considering the euro has followed script smartly – here is an update of the Euro:Silver chart from last Thursday.

From last Thursday’s notes:
“As the euro rips higher today after comments by Jean-Claud Trichet and the newly proposed bailout measures firm the struggling euro-zone, it would be wise to watch silver as a proxy for the currency markets. Since silver broke its parabolic formation over a month ago, both markets have been trading with great correlation – with silver leading the way by several sessions. This makes natural sense in the fact that silver is a much shallower and more impressionable market that will trade with greater nuance to the underlying market conditions. Jawboning by the ECB appears to be only momentarily supporting the euro. I would expect the euro to follow suit lower over the next several sessions.The fact that silver failed to take out the early May dead-cat-bounce highs indicates that the mid May lows will at the very least be tested and likely broken. The violent reversal in silver yesterday gives credibility towards that expectation.”
From my perspective, silver appears to be simply consolidating into its next move which will very likely be lower – considerably lower. The dollar continues to exhibit strong congruency to the early 1980′s bottom.
You could say recently the tail (silver) has been wagging the dog (euro-currencies).This action typically precedes the dog bitting its own tail.

See the original article >>

Curde Oil Market: A $2.5-Trillion-a-Year Global Fake Out? (Guest Post)

Speculators at the NYMEX are doing it again and have NO INTENTION WHATSOEVER of accepting delivery of even 1/10th of the 367M barrels they had as open contracts last week. In fact, Wednesday (June icon cool economy they traded their contracts 454,043 times. It’s a 123% daily churn rate!

Of course, it’s easy to churn 454 million barrels of crude because the only one that ends up paying for all those fees is the end consumer of crude. All those fees are passed on to consumers as part of the price of oil. 

Don’t forget to thank Lloyd and Jamie when you fill up your tank, as Exxon’s CEO Rex Tillerson told us, without those speculators, a barrel of oil would be $70. You can see Jamie sweating as President Obama said a Justice Department probe will examine the role of “traders and speculators” in oil markets and how they contribute to high gas prices. 

Goldman Sachs (GS) and Morgan Stanley (MS) today are the two leading energy trading firms in the United States. Citigroup (C), JP Morgan Chase (JPM), and some other alleged big player are not only major players, but also fund numerous hedge funds as well which speculate in many markets including commodities and crude oil. 

In June 2006, oil traded in futures markets at some $60 a barrel and a Senate investigation estimated that some $25 of that was due to pure financial speculation. That would mean today that at least $40 or more of today’s $101 a barrel price is due to pure hedge fund and financial institution speculation.
Picture1 economy
However, given the unchanged equilibrium in global oil supply and demand over recent months amid the explosive rise in oil futures prices traded on Nymex and ICE exchanges in New York and London, it is more likely that as much as 60% of today oil price, is pure speculation.

No one knows officially except the tiny handful of energy trading banks in New York and London and they certainly aren’t talking. But I will point out that it’s not XOM that makes the lions’ share of the excess profits as speculators drive the price of oil from $40 to $100, it’s JPM, GS et al

On Wednesday, June 1, I noted that there were 367,620 open contracts (1,000 barrels per contract) on the NYMEX at $103 per barrel and I said that the number was total nonsense, and that real demand was 35M barrels at most. One week later, how many contracts are still open for July delivery? 288,420! (See Table)
Picture3 economy
On a global basis, this is a $2.5 TRILLION annual scheme that funnels money from the bottom 99% to the top 1%, but mostly to the top 0.01%. Those guys will do ANYTHING to keep the price of oil as high as possible with no consideration as what that would do to regular consumers and the global economy. 

On Wednesday, June 8, OPEC failed to come to a supply agreement and President Obama said he would release oil from the Strategic Petroleum Reserve if necessary and also, we had an oil inventory report that showed a 2 million barrel BUILD in gasoline over the holiday weekend, indicating a tremendous drop in demand. You would think that would drive prices DOWN but, instead, oil went UP yesterday, from $98 at 8:30 am to $101.89 at 12:30pm! 

These speculators do not REALLY want 288,420,000 barrels of oil delivered to them in July. That would cost them (at $101.60) $29.3 Billion! It’s not just the cost of the oil, they would also have to find a place to put 288M barrels of oil and the US storage system is full. So once we drop 1,000 barrels off in Jamie’s garage and put another 2,000 barrels in Lloyd’s swimming pool (84,000 gallons) – they begin to run out of space pretty quickly.

The retail investors are essentially the “bag holders” who end up taking the contracts off the IBanks hands at the very top of the market (usually a couple of days after Goldman Sachs predicts $200 oil), with their 401K money tied up in ETFs like United States Oil Fund (USO), which was at $40 in June of 2009, when oil was $70 a barrel and is still at $40 with oil at $101.60 a barrel. Yet retail investors own $1.4Bn worth of futures contracts and, even worse, they tip their hands on what they are going to trade!
Picture2 economy
Most commodity ETFs end up just taking whatever hedge funds are dumping, but as you can see from the chart above, USO is one of the worst as their constant rolling over of contracts and 0.45% “management expenses” virtually guarantees long-term holders nothing but PAIN.

When you buy USO, it is the same thing the speculators are doing at the NYMEX–pretending you want oil that you will never accept delivery of, so all you can do is hope to find another patsy tomorrow to take the contract off your hands. As you can see from the performance of USO – there are no other marks – the buck (or the barrel) stops right there!

If you want to invest in oil long-term, buy ExxonMobil (XOM) – they are UP 40% over the same period with a 2.4% dividend. If you are playing along at home, futures trading is dangerous! If you are going to play, make sure to scale in and use stops, and also need to take profits and run on small reversals.

What the U.S. Dollar & the Euro Mean to the S&P 500

by J.W. Jones

The buzz around the blogosphere and in the media is that Quantitative Easing II is scheduled to end in around 3 weeks. Already pundits are asking about Quantitative Easing III as a matter of when, not if. In reality a QE III Lite version is already in the cards as the Federal Reserve has stated they will be buying Treasuries and Mortgage Backed Securities (MBS) with maturing issues. The Fed also plans on reinvesting the interest earned from the existing portfolio (Roughly $15 billion/monthly).

When it comes to the application of financial principles, doing the opposite of what everyone else does generally leads to an extreme variation in the overall results. While the results are not always better, they are at the very least significantly different from what most lemmings within the group experience. In every aspect of my financial life I try to do the opposite of what the herd is doing. It takes experience and a significant level of discipline, but buying from the herd when they are selling and being willing to sell into a crowd when they are buying is a great way to trade. It sounds easy, but for most people it is not, myself included.

Right now financial markets are uncertain. I would be remiss if I did not point out the recent strength in the U.S. Dollar Index and the potential higher low that it has carved out on the daily and weekly charts. The weekly chart of the U.S. Dollar Index is shown below:
DXart options
The current pattern on the U.S. Dollar Weekly chart is bullish. We could see the U.S. Dollar Index trade significantly higher from here as it has been under severe selling pressure for an extended period of time. While I believe technical analysis is just one context through which to view financial markets, it is uncanny how often market cycles and headline events line up. Is it merely a coincidence that the U.S. Dollar is potentially bottoming around the same time the Federal Reserve is ending the QE II asset purchase program?

Regardless of what camp economists are in, we presently live in a strange time for financial markets and capitalism in general. One of the more interesting charts to study is the Euro currency, which in contrast to the U.S. Dollar Index appears to have a more bearish pattern. Could it be that the U.S. Dollar is setting up to rally because of the perceived weakness of the Eurozone? The daily chart of the Euro ETF is shown below:
EUROart options
The Dollar may be firming up here based on the Euro’s weakness and it may have absolutely nothing to do with QE II ending. I always refer to price action and never question Mr. Market’s directional bias. If the U.S. Dollar begins to work higher what impact will it have on equities?

A stronger U.S. Dollar would certainly put pressure on risk assets, specifically equity and commodity prices. As it turns out, we are at an interesting juncture in financial markets at this point in time.

The 4 year stock market cycle is nearing an end, a presidential election will take place in less than 18 months, the U.S. government has a massive debt crisis developing, and the European debt crisis continues to mature in what will likely be a microcosm of what we will face here in the United States. The Middle East remains tense at the very least and the recent OPEC announcement to maintain supply levels has helped support oil prices.

Higher oil prices have obviously slowed down the U.S. economy as the consumer is strapped with higher costs on nearly everything, specifically food and energy. In addition, the unemployment numbers are seemingly not improving and housing appears to be rolling over . . . again.

Almost everywhere we look the news is bleak. Mr. Market has shrugged off bad news time and time again since the March 2009 lows. The long term shorts remain frustrated to say the least and those who were actively shorting along the way have likely been stopped out multiple times. Everywhere I look market commentary is bearish and pundits are talking about additional weakness as they point to a rallying Dollar and multiple economic headwinds facing domestic markets.

Traders and investors should be focused on a few specific price levels on the S&P 500. With the Dollar rallying, the S&P 500 index has remained under extreme selling pressure for multiple weeks. The S&P 500 (SPX) is likely going to test its 200 period moving average. From there I am expecting a bounce higher, although the bounce may be nothing more than a Dead Cat Bounce.

As always, time and price will be the final arbiter but if the Dollar continues to trade higher we could see the S&P 500 lose its 200 period moving average and eventually test a major support level which needs to hold up for the bulls. If the March 16, 2011 pivot lows are taken out to the downside, the next leg of the secular bear market may be under way. The daily chart of the SPX illustrated below shows the key price levels and the potential price action that may lead up to a key test of the March 2011 pivot lows:
SPXart options
Very rarely does the first mouse get the cheese, so I would anticipate a bounce off of the 200 period moving average which currently coincides with the March pivot lows. With not only the pivot lows but the 200 period moving average offering support a breakdown lower will be a large tell about the health and future price action of the S&P 500.

Right now I am just going to focus on how the S&P 500 handles the key support zone illustrated above. The forthcoming price action will tell traders everything we need to know about the health of financial markets. I have no idea if we are about to enter a double dip recession nor do I know whether price action will even test the March pivot lows.

What I do know is that price action in coming days around key support areas is going to be critical. I am convinced that Mr. Market will tell us whether the bullish party will continue or come to an end in the next few weeks/months. A breakdown of the March pivot lows in the future will likely initiate the launch sequence for the next secular bear market. I would keep the S&P 500 1,250 price level on the radar going forward. Risk remains high.

Chinese Rating Agency Says “The US Has Already Defaulted” … German Rating Agency Downgrades U.S. Debt

By Washingtons Blog

While Baghdad Bob Ben Bernanke says that everything is fine, China’s Dagong credit rating agency says the U.S has already defaulted. As AFP reports:
“‘In our opinion, the United States has already been defaulting….Washington had already defaulted on its loans by allowing the dollar to weaken against other currencies – eroding the wealth of creditors including China, Mr Guan said.”
This follows on the heels of German credit rating agency Feri’s downgrade of U.S. bonds a full notch – from AAA to AA – saying:
“The U.S. government has fought the effects of the financial market crisis primarily by an increase in government debt. We do not see that there is sufficient attention being paid to other measures, “said Dr. Tobias Schmidt, CEO of Feri Rating & Research AG. “Our rating system shows a deterioration in economic health, so the downgrading of the credit ratings of U.S. is warranted.”
Which – in turn – follows American credit rating giant Standard & Poors’ warnings about a potential future downgrade to U.S. credit.

While the deficit hawks will take both announcements of proof that they were right, and the deficit doves will say that people are too concerned with debt and that we need more stimulus, neither are looking at the facts.

The government’s entire approach has been to prop up the lenders by giving trillions to the giant, insolvent banks.

But as economist Steve Keen proved years ago, giving money to the debtors is would have stimulated the economy much more than giving it to the lenders.

As Robert Reich put it yesterday
The problem isn’t on the supply side. It’s on the demand side. Businesses are reluctant to spend more and create more jobs because there aren’t enough consumers out there able and willing to buy what businesses have to sell.
Consumers can’t and won’t buy more.
How to get jobs back, then? By reigniting demand. Put more money in consumers’ pockets and help them renegotiate their mortgage loans.
But we’re not hearing any of these sorts of demand-side solutions from the White House.
(Before you jump to the conclusion that this is a liberal perspective, remember that conservatives are also against rampant inequality, and that Reagan’s budget director called Bush’s tax cuts for the wealthy “The biggest fiscal mistake in history”, saying that extending them won’t stimulate the economy).

And while many people believe that war helps stimulate the economy, that is a myth. The facts show that war – especially prolonged wars like we’ve had in Afghanistan and Iraq – destroy economies.

(Again, before you fall into a false left-right split, remember that true conservatives are anti-war), and that the top security experts – conservative hawks and liberal doves alike – agree that waging war in the Middle East weakens national security and increases terrorism. See this, this, this, this, this and this.)

In fact, according to the non-partisan Center for Budget and Policy Priorities, the Bush-Obama tax cuts for the wealthy and the perpetual wars we’ve been waging for the last decade are by far the largest causes of our national debt:

Of course, while the Center for Budget and Policy Priorities downplays the role of the various bailouts in our debt situation, others might disagree. For example, I pointed out in December:
As I noted in December 2008, the big banks are the major reason why sovereign debt has become a crisis:
The Bank for International Settlements (BIS) is often called the “central banks’ central bank”, as it coordinates transactions between central banks.
BIS points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:
The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened.
In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don’t have, central banks have put their countries at risk from default.
A study of 124 banking crises by the International Monetary Fund found that propping banks which are only pretending to be solvent hurts the economy:
Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.
Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.
All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.
Now, Greece, Portugal, Spain and many other European countries – as well as the U.S. and Japan – are facing serious debt crises. We are no longer wealthy enough to keep bailing out the bloated banks. See this, this, this, this, this and this. [and this and this.]
Indeed, the top independent experts say that the biggest banks are insolvent (see this, for example), as they have been many times before. By failing to break up the giant banks, the government will keep taking emergency measures (see this and this) to try to cover up their insolvency. But those measures drain the life blood out of the real economy.
And by failing to break them up, the government is guaranteeing that they will take crazily risky bets again and again, and the government will wrack up more and more debt bailing them out in the future. (Anyone who thinks that Congress will use the current financial regulation – Dodd-Frank – to break up banks in the middle of an even bigger crisis is dreaming. If the giant banks aren’t broken up now – when they are threatening to take down the world economy – they won’t be broken up next time they become insolvent either. And see this. In other words, there is no better time than today to break them up).
The bottom line is that the issue is not whether liberal “Keynesian” or conservative “austerity” philosophies are right. (The war between liberals and conservatives is a false divide-and-conquer dog-and-pony show. See this, this, this, this, this, this, this, this, this and this.)

The issues are pilfering of our economy by the wealthiest .1% and the waging of imperial wars for reasons other than our national security (and see this).

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