Friday, August 12, 2011

Risk On or a Stretch for Yield

US Treasuries, as measured by the iShares Barclays 20+ Year Treasury Bond Fund (ticker: $TLT), have roared higher in a parabolic move. A flight to safety? But the the last couple of days there are signs of a possible pullback. When $TLT is reviewed against the iShares S&P National AMT-Free Muni Bond Fund (ticker: $MUB) and the SPDR Barclays Capital High Yield Bond Fund (ticker: JNK) it raises the question of whether there is a move to add risk happening or just a stretch to pick up yield. Let’s take a look.

The $TLT against $JNK ratio chart above shows a strong move higher over the last two weeks as the flight to safety began. Peeking out of the Bollinger bands on Wednesday and then dropping hard on Thursday. It could still find support at the 2.66 level but with the strong move lower finishing on the low, it looks to continue down. Moving from Treasuries into High Yield is a clear sign of adding risk.

The $TLT against $MUB chart shows the same pattern. A move out of Municipals into Treasuries ending Thursday with a sharp move back into Muni’s. Again this finished on the lows and bodes for more flow out of Treasuries. This strikes me as more of a stretch for yield, since the Muni’s are often yielding more than Treasuries and are tax free.

So which is it? Risk on or a stretch for yield. Before you answer let me pose that perhaps they are one and the same. This is the start of the fiscal year for Municipalities and the first one with reduced Federal funding. So perhaps a move to Muni’s is also a move to more risk. And with the move higher in Treasury prices a shift into High Yield could be just a move to increase income. So risk on and a stretch for income. Or maybe this is just a tired Treasury Bond that pulled back a bit before another leg higher. This will be easy to see if the $TLT reverses on Friday or early next week.

Germany Must Defend the Euro

Financial markets abhor uncertainty; that is why they are now in crisis mode. The governments of the eurozone have taken some significant steps in the right direction to resolve the euro crisis but, obviously, they did not go far enough to reassure the markets.

At their meeting on July 21, the European authorities enacted a set of half-measures. They established the principle that their new fiscal agency, the European Financial Stability Fund (EFSF), should be responsible for solvency problems, but they failed to increase the EFSF’s size. This stopped short of establishing a credible fiscal authority for the eurozone. And the new mechanism will not be operative until September at the earliest. In the meantime, liquidity provision by the European Central Bank is the only way to prevent a collapse in the price of bonds issued by several European countries.

Likewise, Eurozone leaders extended the EFSF’s competence to deal with banks’ solvency, but stopped short of transferring banking supervision from national agencies to a European body. And they offered an extended aid package to Greece without building a convincing case that the rescue can succeed: they arranged for the participation of bondholders in the Greek rescue package, but the arrangement benefited the banks more than Greece.

Perhaps most worryingly, Europe finally recognized the principle – long followed by the IMF – that countries in bailout programs should not be penalized on interest rates, but the same principle was not extended to countries that are not yet in bailout programs. As a result, Spain and Italy have had to pay much more on their own borrowing than they receive from Greece. This gives them the right to opt out of the Greek rescue, raising the prospect that the package may unravel. Financial markets, recognizing this possibility, raised the risk premium on Spanish and Italian bonds to unsustainable levels. ECB intervention helped, but it did not cure the problem.

The situation is becoming intolerable. The authorities are trying to buy time, but time is running out. The crisis is rapidly reaching a climax.

Germany and the other eurozone members with AAA ratings will have to decide whether they are willing to risk their own credit to permit Spain and Italy to refinance their bonds at reasonable interest rates. Alternatively, Spain and Italy will be driven inexorably into bailout programs. In short, Germany and the other countries with AAA bond ratings must agree to a eurobond regime of one kind or another. Otherwise, the euro will break down.

It should be recognized that a disorderly default or exit from the eurozone, even by a small country like Greece, would precipitate a banking crisis comparable to the one that caused the Great Depression. It is no longer a question whether it is worthwhile to have a common currency. The euro exists, and its collapse would cause incalculable losses to the banking system. So the choice that Germany faces is more apparent than real – and it is a choice whose cost will rise the longer Germany delays making it.

The euro crisis had its origin in German Chancellor Angela Merkel’s decision, taken in the aftermath of Lehman Brothers’ default in September 2008, that the guarantee against further defaults should come not from the European Union, but from each country separately. And it was German procrastination that aggravated the Greek crisis and caused the contagion that turned it into an existential crisis for Europe.

Only Germany can reverse the dynamic of disintegration in Europe. That will not come easily: Merkel, after all, read the German public’s mood correctly when she made her fateful decision, and the domestic political atmosphere has since become even more inhospitable to extending credit to the rest of Europe.

Merkel can overcome political resistance only in a crisis atmosphere, and only in small steps. The next step will likely be to enlarge the EFSF; but, by the time that step is taken, France’s AAA rating may be endangered. Indeed, by the time Germany agrees to a eurobond regime, its own AAA standing may be at risk.

The only way that Europe can escape from this trap is by acting in anticipation of financial markets’ reactions, rather than yielding to their pressure after the fact. This would require intense debate and soul-searching, particularly in Germany, which, as the EU’s largest and best-rated economy, has been thrust into the position of deciding the future of Europe.

That is a role that Germany has been eager to avoid and remains unwilling to accept. But Germany has no real choice. A breakdown of the euro would precipitate a banking crisis that would be beyond the global financial authorities’ ability to control. The longer Germany takes to recognize this, the higher the price it will have to pay.

George Soros is Chairman of Soros Fund Management and of the Open Society Institute.

The BiPolar Market

By Barry Ritholtz


That is the only way I know how to describe the market action of late. The week is likely to end flat — no losses or gains — but it sure didn’t feel that way.

Markets have just lived through 4 consecutive 90% Trading Days. That is a session where 90% of the stock trading volume and the number of advancers versus decliners is to one sided. These 90% Days are defined by their extreme intensity. They are typically associated with panic selling and on occasion, panic buying.

Four consecutive 90% Days is extremely rare, and according to Lowry’s Technical service, this week was “only the second time since 1940 that four consecutive 90% Days have been registered.” Floyd Norris of the NYT found 3 instances of consecutive 4+% swings.

And most unusual of all, there is no historical precedent where we had four consecutive 90% Days that saw each reversed in the next trading session, i.e., Down Up Down Up.

The technicians will call this high volatility, but to me, its merely a case of BiPolar behavior. I would note the following five observations:
1) There is no clear trend. Anyone who engages in trend trading is likely out of this whiplash environment. Why guess when you can wait for a better defined trend line?
2) A 1% muddle through economy has been discounted is mostly priced in at a 20% drop in prices; Even a mild recession is mostly in the price. However, a serious recession, where earnings fall 30-40%, has certainly not been reflected in prices yet.
3) Market have become extremely oversold. Not quite January 2009 levels (which fell further) but at least to Flash Crash levels. A bounce over days or weeks is increasingly probable.
4) The possibility of more eventual selling exists: The short time window makes unlikely that this is the last of the selling; we have adjusted downward and now await further data about European banks and the US economic slowdown.
5) The downgrade of the US from AAA to AA+ is likely the first domino to fall; look for further downgrades to major European states, and the ECB itself. What matters is not the downgrade but the reaction in the markets.
The question that you must ask yourself: “Are you a trader or an investor?” will determine if you should be playing in shark infested waters.

Why “Made in China” Costs More in China

by Waiching Li

While Americans are faced with continuing economic hardship and complain about cheap ‘made in China’ products undermining local manufacturing, the Chinese would likely respond that Americans are actually getting a better deal! A recent survey shows, that the cost of living in Beijing and Shanghai has already surpassed New York, even though China’s gross income per capita 2010, measured by purchase power parity is only a sixth of United States.

In China, a pair of Nike shoes on sale price is almost 100 dollars. Levis jeans 799 yuan ($122), Tommy Hilfiger T-shirts 799 Yuan ($145). A grande sized cup of Starbuck’s coffee costs $5.23(34 yuan); and one scoop of Haagen-Dazs ice cream costs $4.3 (28 yuan ). Any western fashion brand from GAP to Versace, even clothing made in China, are priced 30% to several times more than the same product in the US. An Armani suit sold in US for $ 1000, has an asking price above $4500 (30,000 yuan) in China.

While China is the world’s factory, making most consumer eletronics, domestic consumers always have to pay more for the products made in their backyards. A 16 GB iPad is sold the in U.S for $499, but Chinese customers have to pay an amount equal to $757. Even the Chinese native brand Lenovo is selling at a price 10% higher than it is in U.S. An irony most Americans are unfamiliar with is that most “Made in China” products are actually more expensive in China than they are in U.S.

Considering that the average Chinese person is still making significantly less than their American counterparts, such a large pricing disparity does not make much sense. It is easy for an American to conclude that it is all due to ‘artificially under-valued yuan by Chinese government’, a charge Americans often hear from the media regarding the trade imbalance. While such an assertion has some validity, it is only one stroke of the Chinese character.

Tax Exemption Is the Key

In China, exported goods are exempted from domestic consumption related taxes. To the Chinese government, export-led manufacturing was an employment solution to absorb the massive surplus of rural labor. Tax exemption on export-led manufacturing was an accommodating strategy to encourage the growth of the manufacturing base. There are two major models of export entrepreneurships: processing on order and direct export. Processing on order plants are often set up in tax free economic zones, where foreign entrepreneurs bring in raw materials, tools, technology, etc., China supplies hard working, disciplined labor, and all finished products are shipped overseas.

The other model is direct exporting entrepreneurship which receive the same tax treatment as any other business, but they can get a full tax rebate when transaction documentation proves exportation occurred. Tax exemption is the single most important factor separating prices in China and the US.

In China the government is heavily reliant on tax collections from the logistic chains of goods flowing to domestic consumers. Almost seventy percent of tax revenues are collected from consumption related taxes (i.e. value-added, consumption, business tax, tariff, and related taxes), while the remaining 30% is from personal income, corporate income, and other taxes.

Among the consumption taxes collected, value-added tax is the most significant. Each turnover of goods going through the supply chain is subjected to a standard VAT of 17%. Food and household fuel is taxed at 13% and small businesses are taxed at 5%. This tax alone accounts for almost 60% of the government’s annual revenue.

Consumption tax rates range from 5% to 45%, and is imposed to 14 main categories. Goods which are deemed as luxury, harmful to your health, or depleting of rare natural resources are taxed at the highest rates. Some examples are tobacco, alcohol, jewelry, forest products, etc. Business tax is imposed on service rendered transactions usually at 5%.

Since tax reform began in 1994, the annual tax revenue has grown almost twice as fast as the GDP rate. It is debated in China, that the current tax structure almost holds domestic consumption hostage. As outspoken economist Lang XianPing asserted, consumption related tax is an obstacle for China to move toward a consumption economy.

Take cosmetic products as an example, it was reported that for every 100 yuan worth of cosmetics sold, 14.53 yuan is value-added tax, 25.64 yuan is consumption tax, and 4.02 goes to urban construction tax. These three tax items alone, total 44.19% of the sale price.

Imported goods are also subjected to tariff. To sell an iPad made in China’s tax free zone, Apple has to ship it out of mainland China, then ship it back through customs and pay tariffs which latest rate is 10% of it’s cost.
Value-added tax is not used in the U.S. Wholesale and sales of raw materials or unfinished goods are not taxed. Only sales to end customers are subjected to sales tax with a rate generally less than 10%.

Inflation Eats Away the Value of Yuan

Inflation is the other primary reason pushing prices up in China. Even though China is being pressured internationally to appreciate its currency, the persistent inflation has been eating away the purchasing power of yuan in domestic market. In 1980, 1 Jin (1.1023 lb) of pork costs 0.96 Yuan, today the same amount costs 16 Yuan ($2.42), price increasing of 16 times in 30 years. The latest report of CPI ended in June has surged 6.4% from a year ago. Empirically, many food and household item prices have gone up much more than that rate. Pork price has gone up for 70% in ten months.

Some Chinese economists believe that the current surge of inflation was caused by over supply of yuan in the past two years. To levy the effect of global financial meltdown, China issued a 4 trillion yuan stimulus package, which was mainly funded as loans by the banking system. The balloon of credit rapidly increases the M2 supply; and meanwhile, China still maintains pegging to the dollar even with massive surplus in current account from export and capital inflow. In order to keep the pegging, China’s central bank has to issue proportional amount of yuan into circulation for every dollar coming in, further popping up the supply of M2, and intensifying the domestic inflation pressure.

Logistics Still an Obstacle

Logistical deficiency in distribution of goods apposing as one of the biggest problem for China to boost consumption. The transportation expenditure significantly adds up to the cost of goods sold.

In the past 20 years, China has built the world’s second most extensive highway system, but since government funding was limited, most highways were built as investment opportunities, and are for profit.

It was reported, that among the 140,000 km of toll roads in the world, 100,000 km is in China. The Chinese government tries to limit the number of tolls to one station every 50 km, but in some areas, drivers have to dig into their pocket after traveling less than 20 km. In addition to toll, random charges of fees levied by local governments along the highway also significantly add up the cost of transportation.

Reported news indicates that a kilogram of cargo shipped from Shanghai to New York costs ¥1.50 while the same weight shipped from Shanghai to Guizhou (the capital city of an inner province that is 2000km away) costs between ¥6-¥8. This makes the total cost of shipping from Shanghai to Guizhou 4-5 times as expensive as shipping to New York, which is 11862 km away. Transportation costs added to storage, and distribution management costs, lead to logistics costs 18% of GDP, that’s more than twice as much as the U.S

Yuan Pegging to Dollar Benefits U.S

Today, China is a top exporter of the world, and ‘Made in China’ has become an inescapable presence in American life. But the irony is that often Chinese exports are not Chinese products. Rarely have Chinese brands made it into the consciousness of American consumers. Among the 61 Chinese companies that made into the global 500, only Lenovo is somewhat recognizable.

In reality, often ‘Made in China’ is only a component of the global manufacturing supply chain sitting on the lower end of the earning scale. It was reported that for an iPad produced in China, selling for $499 in the US market, only $11.2 goes to China.

Chinese migrant workers work long and hard on assembly lines, producing goods that are bought in dollars by U.S consumers. The Chinese central bank takes in dollars which is used to buy U.S treasury notes, increasingly on the risk of default. The Chinese workers receive yuan as compensation, while high inflation is eating away at it’s purchasing power.

 Chinese get the jobs, while Americans get the consumer products; Chinese government gets the dollar, but the U.S government gets to spend the dollar! Chinese like to say: the Americans get a better deal!

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Beef-Demand Building Efforts To Increase

by TheCattleSite

US - Increases in support for beef demand-building efforts were approved by directors of the Federation Division of the National Cattlemen’s Beef Association (NCBA) at the organisation’s Board meeting held last week in conjunction with the 2011 Cattle Industry Summer Conference in Kissimmee, Florida.
Additional funding will go to programmes funded through the Beef Promotion Operating Committee (BPOC) and a special Federation Initiative Fund that channels money from states with large cattle populations to those with large consumer populations.

Federation directors voted to allocate $750,000 in expected surplus Federation funds to supplement the funding requests that will be considered by the BPOC in September. The BPOC determines national and international programmes for building beef demand. The funds are invested by state beef councils and are in addition to a $5.13 million initial FY2012 investment approved by the Federation Executive Committee and Federation directors.

According to David Dick, a beef producer from Sedalia, Missouri, and chairman of the NCBA Federation Division, the additional funds will be put to good use. “Matched with funds from the Cattlemen’s Beef Board (CBB), this money will support demand-building programmes that benefit US beef producers,” he said.

“It’s important that we put the money where it will do the most good.”

In that spirit the Federation also approved $198,300 in spending on demand-building projects through its Federation Initiative Fund. A total of $246,550 had been requested from the fund by 10 state beef councils in large consumer population states. The fund is made possible by state beef councils that have more cattle than people.

“Producers on state beef council boards across the country control half of the one dollar mandatory national beef checkoff they collect,” said Mr Dick. “While most of that money is used for in-state demand-building programmes, we’re also able to strengthen the national programme and get other funds where they’re needed badly.”

The NCBA Federation Division represents the 45 Qualified State Beef Councils, and elects 10 members to the 20-member BPOC. The other 10 are elected by the CBB. The BPOC determines which projects and programs will be funded through the 50 cents of each checkoff dollar sent to the CBB.

Other Actions

Also at the Summer Conference, Federation directors heard more about progress made through a Charter they approved at their meeting in Denver in February. The Charter establishes that the Federation is independent within NCBA.

Among the steps taken since February have been the hiring of a senior staff member whose sole responsibility is Federation activities, and the hiring of a compliance officer who helps assure that time and expense controls of Beef Checkoff funds are properly implemented.

“As a committed partner with CBB, we want to make sure that we have 100 per cent accountability,” said Mr Dick. “At the same time, we value the synergies that our association with NCBA provide.”

At the event’s Federation Forum state beef council representatives presented ways the Federation was involved with programmes taking place in their states. Staff from the Idaho Beef Council utilised Federation assistance in a state-initiated consumer promotion project, while the Nebraska Beef Council provided significant assistance in a nationally-developed Issues Management programme in Nebraska.

“State beef councils and their staffs are key to the Federation’s success,” said Mr Dick. “Not only do they financially support national Federation efforts, they directly participate in Checkoff-funded efforts taking place in their states. It’s a close relationship that works well.”

Let the Bulls Run!!

Let the Bulls Run!!! The USDA blows away the trade by estimating a 153 corn yield, and a 41.4 soybean yield. Total corn production is now estimated below 13 billion, and new crop soybean ending stocks fall to an extremely tight 155.

I have found at times it is often very tough to communicate thoughts or direct feelings into words on paper. Sometimes I may come across as being "bearish" when I am actually "bullish" longer-term. What I have been trying to communicate as of late might be better explained by painting a more vivid picture.

I want you to envision a group of fund traders all trying desperately to push a large rail-car up a steep mountain. The mountain represents "price." The higher prices climb the steeper the mountain becomes and the more difficult the rail-car is to move. At our current price level, I have to believe we are at least 3/4 of the way up the mountain, if not more. We have over 325,000 active participants (the funds) trying to push the rail-car as hard as they can up the mountain side. The grade of the mountain is getting steeper, and the rail-car seems to be getting heavier with each push. As we move the car higher up the mountain, "demand" seems to be providing less and less help.

We are however getting a nice boost from "yield," who as of late has actually helped us gain some additional ground. However, all around the mountain traders are watching other rail-cars fall off the tracks and flatten those that were pushing that particular rail-car (i.e. crude oil, stock market). What I am trying to say is that we need all the man-power we can muster just to push the rail-car up this last increasingly steep part of the mountain. If for some reason a few of our 325,000 plus "pushers" decided they have had enough (get scared) and walk away, we might actually loose some footing and at least temporarily, give back some ground. I have to believe once the rail-car is secured and comes to stop on solid footing, it will assure "pushers" that the rail-car is not going to tumble completely down the mountain. Once that plays out it wouldn't surprise me to see us end up with 400,000 or maybe even 500,000 plus "pushers" (fund traders) that take us right back towards the top of the price mountain. The magic question seems to be, "How far will we make it before the terrain simply becomes too steep?" I personally believe we have reached a level where footing could become an issue at any given moment. We desperately need all hands on deck, but with the "outside" markets in shambles, I am just not sure we will receive the extra man-power.

Remember, the re-survey was only for the Dakotas, Minnesota and Montana. We will not see what type of total damage was caused by the Missouri and Mississippi river flooding until early fall, nor will we know what type of total crop abandonment and acreage loss due to extreme drought like conditions has occurred either. These are certainly more "bullish" cards that have been loaded into the deck, along with the potential for extreme wind and hail damage, and thoughts of any type of early freeze. I have to believe the fear of these being dealt on to the table are still several weeks away, so we will need to sit patiently by and wait for some type of extended profit taking or setback to position ourselves for the next round of "bullish" cards.

Morning markets: mood of caution ensnares commodities rally


It pushed and it pushed, but couldn't quite get there. And ended up retreating.
The high for Chicago's best-traded corn lot, December, is $7.22 ¾ a bushel, set in June, the last time concerns over the thinness of US supplies of the grain peaked.
On Friday, it reached its highest since, $7.20 a bushel, but failed - in early deals at least - to lift the bar higher, despite the boost from Thursday's downgrade by US Department of Agriculture officials to their estimate for the domestic corn yield, and harvested area, this year.
Indeed, the theme of a more muted reaction than might have been expected to the data, and a bigger-than-forecast downgrade to the US soybean crop too, looked only more relevant on Friday.
All three of the Chicago major crops fell in early deals.
Crude eases
One downer was the performance of external markets, which failed to react quite as might have been expected given a bounce of more than 3% in the Dow Jones Industrial Average overnight, helped by data showing a 395,000 drop in the number of claimants of US unemployment benefits last week, to a four-month low.
Tokyo's Nikkei index closed 0.2% lower, while New York crude dipped 1.7% to $84.30 a barrel as of 07:25 GMT (08:25 UK time) amid concerns for what the dip in sentiment fostered by the recent market mayhem has done for demand.
Other reasons proffered for soft markets included the day of the week, with investors cautious in such volatile times ahead of the weekend break, and a ban by some eurozone countries - France, Spain, Belgium and Italy - on short-selling financial stocks, in an effort to protect their banks.
Such moves have a rich history of highlighting the severity of the situation rather than promoting calm.
Furthermore, the dollar made headway against a basket of currencies, by 0.3%, making dollar-denominated assets less affordable as exports. (However, China may be an exception, see below.)
'Outlook remains rangebound'
And in crop markets there was some caution too over taking too much of a lead from Thursday's USDA data with much of the season yet to go for spring-sown crops.
For soybeans, for instance, the "price outlook remains rangebound from $13.00-14.00 a bushel till more is known about US crop production in September or October", Kim Rugel at Benson Quinn Commodities said.
For wheat, many analysts voiced a positively downbeat stance, given that the USDA downgrade to hopes the US crop was more than offset by better prospects elsewhere, notably in the former Soviet Union.
"World wheat projections were bearish for prices," Luke Mathews at Commonwealth Bank of Australia said.
"The USDA lifted global production by some 10m tonnes this month and ending stocks were lifted by about 6m tonnes to a comfortable 189m tonnes."
At, Standard Chartered, Abah Ofon said: "We remain fundamentally bearish wheat into the end of the year, although wheat prices are likely to benefit from bullish sentiment in corn."
Yuan factor
As for overnight news, the China National Grain and Oils Information Centre lifted its estimate for China's corn harvest by 1m tonnes to 182.5m tonnes, potentially a negative for prices. (The USDA on Thursday pegged the figure at 178.0m tonnes).
However, the centre cut its forecast for the soybean harvest by 500,000 tonnes to 13.5m tonnes, below the USDA's 14.0m-tonne figure.
And, in what might be seen as an extra boost for crops – such as soybeans - of which China is an importer, the country again pegged the yuan higher, at 6.3972 yuan per $1, its sixth record high in 10 trading days.
"This accelerated appreciation [of the yuan], both against the dollar and on a trade-weighted basis, marks an important shift after a recent slowdown," StanChart said.
Prices fall
Nonetheless, Chicago soybeans for November fell 0.3% to $13.28 a bushel, while corn for December fell 0.2% back to $7.12 ½ a bushel.
Wheat for September fell 0.3% to $6.99 ½ a bushel.
To continue the contrarian theme, a notably good performer was cotton, which was served bearishly by Thursday's USDA data revisions, which put in a surprise upgrade to the US harvest, despite deep drought in Texas, America's top producing state.
Is cotton, of which China is like soybeans also the top importer, reacting better to yuan appreciation prospects?
New York's December lot added 0.8% to 97.25 cents a pound.

US corn woes to lift futures 'to record highs'


Corn prices are to challenge record highs set in June, boosted by the downgrade of the US crop which has left the world facing its tightest supplies of coarse grains on record.
The US Department of Agriculture's 556m-bushel downgrade on Thursday to its estimate of the American corn harvest this year made it "increasingly likely that Chicago corn prices could test" their June 10 record, when the spot contract hit $7.99 ¾ a bushel, Rabobank analysts said.
"Although farmers have clearly responded to record-high prices through increased corn plantings, the adverse weather is likely to extend the current elevated prices," the bank said.
The USDA, explaining its corn crop downgrade, said that "unusually high temperatures and below average precipitation during July across much of the Corn Belt sharply reduced yield prospects", with drought in the South raising expectations for abandoned crops.
'Critically tight'
At Commonwealth Bank of Australia, Luke Mathews said that "extremely tight" supplies of the grain highlighted by the revision meant corn futures "are likely to test, if not exceed, the June record high"
The cut to 714m bushels in the USDA estimate of domestic corn stocks at the close of 2011-12 "should continue to support near-record corn prices", he added.
Furthermore, with estimates for US barley and sorghum harvests also cut, the country's level of feed grains looked "critically tight", putting a squeeze on global supplies too.
The ratio of global carryout stocks of coarse grains, as a proportion of use, implied by the data was – at 12.8% - "the tightest on record".
Ethanol factor
Rabobank added that, while the USDA also cut estimates for domestic corn consumption and exports, as high prices ration demand, futures may have to go higher still to deter the bioethanol plants who consume nearly 40% of American production.
"[It] would require corn prices in excess of $7.50 a bushel to make ethanol production unprofitable at current ethanol prices," the bank said.
Chicago's December corn contract stood at $7.12 ¼ a bushel in early trade on Friday, down 0.3% on the day.
Ethanol for December delivery closed up 2.2% at $2.591 per gallon on Thursday.

Soybeans jump after 'blowtorch heat' wilts US crop


Soybean futures jumped in early deals after the US cut its production estimate by considerably more than the market had expected, signalling a squeeze on supplies which looks set to have global repercussions.
The US Department of Agriculture cut its estimate for the US soybean yield this year by 2.0 bushels per acre to 41.4 bushels per acre – a downgrade twice as big as analysts had expected.
Furthermore, it reduced its estimate for harvested acres by 500,000 acres to a four-year low of 73.8m acres, reflecting a trim to estimates for sowings, after a rain-hampered spring planting season, and damage caused by heat to crops in Texas and Oklahoma.
"The early wetness and then the blowtorch heat took a toll," broker US Commodities said.
'Rationing needs to occur'
The data implied a US crop of 3.06bn bushels (83.2m tonnes), nearly 130m bushels short of trade expectations, and signalling that prices would rise to slow demand accordingly.
USDA US soybean data, diff. from last, and from (market forecast)
Harvested area: 73.8m hectares, -0.5m acres
Yield: 41.4 bushels per acre, -2.0 bushels per acre, (-1.4 bushels per acre)
Production: 3.06bn bushels, -169m bushels, (-131m bushels)
Year-end stocks: 3.15bn bushels, -118m bushels
Estimates for 2011-12. Market estimates from ThomsonReuters
"Rationing needs to occur on soybeans," US Commodities said.
Farmers could expect to receive up to a record $14.50 a bushel for their soybeans in 2011-12, up $0.50 a bushel from the previous upper estimate, the USDA said.
In Chicago, soybeans for November, the best traded contract delivery soared more than 4% in early deals before easing to $13.34 ½ a bushel at 17:30 GMT, up 2.5% on the day.
'Going to affect China'
The USDA foresaw the reduction in supplies being felt in part by domestic crushers, who looked set for a second successive season of reduced activity in 2011-12.
Selected USDA soybean forecasts, change on last, and (year on year)
Brazilian production: 73.5m tonnes, +1.0m tonnes, (-2.6%)
Brazilian exports: 36.5m tonnes, +2.5m tonnes, (+22%)
Chinese production: 14.0m tonnes, -0.3m tonnes, (-7.3%)
World production: 257.5m tonnes, -4.0m tonnes, (-2.5%)
Year-end stocks to use ratio: 23.2%, (-0.4 percentage points), -3.8 percent points
Estimates for 2011-12
However, importers are to take a bigger hit, with the forecast for soybean exports from the US –the world's biggest shipper - downgraded by 95m bushels to 1.40bn bushels (38.1m tonnes).
Although prospects for exports from Brazil looked brighter, buyers, including top-ranked importer China, faced paying up for supplies, analysts said.
"It is going to affect China the most," Sal Gilbertie, head of Teucrium Trading, told
"China has been importing quite a few soybeans again, to feed its growing hog herd and meet consumers' growing demand for protein."
Date on Wednesday showed China's soybean importers rising by nearly one-quarter in July, from June.
"China is going to feel the impact of the tighter soybean supplies."

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An Update on $VIX

by Doug Short

The first chart features an overlay of the S&P 500 index and the CBOE Volatility Index (VIX) since 2007. Yesterday the VIX rose to 48.00, a gain of 50% over the previous close.

Follow up:
Click to View

As the chart above illustrates, the correlation between the S&P 500 and the VIX is inverse but imperfectly so. The lower low in the summer of 2008, when the index nearly dipped to 1200, came with a lower VIX in the upper 20s. More significantly, the unprecedented surges in the VIX above 80 in late 2008 predated the actual index low by over three months.

A key to understanding the VIX is to realize that it can be far more volatile than the index to which it is attached. The next chart inverts the VIX values, which helps us see more clearly the greater degree volatility and the fact that the VIX tends to lead the S&P 500.

The spike in the VIX of late is a bit worrisome, especially because it has exceeded 30 level associated with high volatility. See also the markers at the bottom of both charts, which identify days on which the VIX spiked by more than 30%, something that's happened four times since the March 2009 low. In particular, we can see the increase in volatility associated with the 16% correction that began in April 2010 and ended in early July. The immediate question is whether the spike in volatility during the past few days, which included two 30% plus spikes, is a leading indicator of additional market decline.

For a look at the VIX and S&P 500 since 1990, click here for some additional illustrations.

Option Decay and the Days of Our Lives

“Time is on my side, yes it is…You’ll come runnin’ back, you’ll come runnin’ back, you’ll come runnin’ back to me.” ~Rolling Stones

Who would have thought that The Stones were cutting edge advocates of selling options? After all these years, it finally dawned on me that Mick and Keith devoted this song to the propensity for option prices to “run” back to their strike price, and eventually expire worthless. Of course, they were also telling people to “get off their cloud” well before cloud computing became the newest rage.

The purpose of this article is to acquaint the reader with one of the elements used to price options-time. In a way, this component would seem to be intuitively simple. Perhaps the reason for the perceived simplicity is that many are familiar with the traditional real estate option. Generally, the plain vanilla real estate option creates a contract where a property owner will, for a fee, grant a potential buyer an option to buy subject property for a set price, within a stated time period. It is anticipated that the price of the option will vary, and the chief determinant of that variation is time. This aspect is readily understood, as an owner of property will refuse to encumber his property, unless adequate consideration is paid to compensate for a given time interval. And, as everyone knows, if the option is not exercised, the property owner will pocket the option money.

In the typical real estate scenario, the buyer probably has a legitimate interest in buying the property. But, during real estate bubbles, the buyer may want to “flip” the option to someone else and collect a fee for selling the option. Whatever the circumstance, if one were asked to ‘value’ the subject option on a daily basis, the value ascertained would no doubt reflect a linear amortization. Thus, the stated price of the option, divided by the number of days in the option period, would yield a daily value. On any given day, the preceding day represents a value proportionately greater than the next day, and so on. So, the tick of the clock and the passage of days are quite predictable, as the option decays in linear fashion. We can conclude that there is absolutely no ‘sensitivity’ to any external event. Suppose that on the morning of the last day of the option contract, developer announces major development plans for the immediate area. The announcement causes real estate values to skyrocket in the surrounding area, including the subject property.

In order to put time on our side we must understand risk and the concept of mathematical expectancy. In the above real estate example, we altered the facts to allow for a spike in value. In the final analysiseven the simple real estate option isn’t linear in reality- although, for accounting purposes, linear amortization is the norm. Suppose that a mere rumor surfaced about the development, as opposed to a definitive announcement. Or, to take another perspective, assume that the subject property was suddenly re-zoned in such a way as to lower its present value.


Both the buyer and seller of an option are betting on the clock. The buyer of an option wants enough time for the option to gain more than he paid for it. On the other hand, the seller hopes to simply run out the clock. In short, the option seller is betting on either a static or decaying universe. (As an interesting aside, the Second Law of Thermodynamics gives the edge to decay, or entropy). In any event, however, time transforms and shapes risk. The game will always begin at a point defined as ‘now’, and continue until some specified date in the future.

As to the subject of options, studies show that most options expire worthless. There is some debate as to the exact percentage, as well as the assessment methodology, but even a conservative number indicates an expiration ratio of some seventy percent. If a casino is perfectly happy with a winning ratio of fifty-one percent, a ratio approaching even the most conservative option expiration estimate would make for some very happy casino owners.

“Like sands through the hour glass, so are the days of our lives.” MacDonald Carey

Mr Carey probably had options on his mind, as he so elegantly and poignantly spoke those words for so many years. In dealing with the concept of time via option risk, we must change our perception of the speed at which the grains of sand flow through our ‘hourglass.’ Specifically, while we know that a 30 day option must expire on or before the clock runs out, the sand can actually accelerate or even recapture some grains before the ultimate result.

Imagine a giant warehouse, full of thousands upon thousands of clocks. All of these clocks are set to sound their alarm at precisely the same time. But, to an observer, something is terribly inconsistent. It appears that every clock is either too fast or too slow to possibly chime in unison at the specified time. Yet, we know that all of the thousands of clocks will converge, finally sounding a cacophony of chimes-at the precise moment. If we had an ‘hourglass’ that was converted to a thirty day structure, we could go away for the requisite time period and return to find that all of the sand had filtered from the top portion of our massive time piece, to the bottom. Supposethat we left a video camera to record the second-by second movement of the sand. What a strange and curious video we would encounter.

Even though the ‘days of our lives’ run on a strictly linear process, our time-piece is non-linear, as are the thousands of clocks in our warehouse. Thus time is somewhat of an illusion when we suspend the rules of linearity. Of course, as The Guess Who emphatically state, when there is no more time, there truly is no more time. Sothe game will end at the buzzer, as expected, and all clocks will chime in final harmony. It can be said that we perceive ‘time distortion’ thru the relative position of volatility. At various points along our thirty day time journey, it will seem that we travel at different speeds. At times, it appears that we walk in slow motion, and at other times, we travel on a rocket. But, despite our own particular clock or mode of travel, we can never completely reach our destination ahead of time. On the other hand, we are allowed to freeze our clock or cut our trip short.


A pessimist might point out that we begin to die at birth. It is certainly the case though; that an option will begin to die at the moment it is contracted. It should come as no surprise that there is a precise mathematical equation that reflects this fundamental law. In fact, Fischer Black and Myron Scholes brought a mathematical approach to options pricing in 1973, with the publication of their seminal piece in ‘The Journal of Political Economy.’ Robert Merton extended the model, and a Nobel Prize in Economic Services was awarded in 1997 for their efforts. Of course, genius alone is no defense against an often bewildering market, as evidenced by Merton and Scholes’ links to the Long-Term Capital Management debacle.

And, I’ve known math doctorates that can pontificate on options pricing methodology, but who somehow can’t seem to parlay that knowledge base into profitable trading strategies. So, just as some truly great musicians can play by ‘ear,’ so it is that one can become a very successful options trader, without possessing a strong mathematical background. Perhaps, the best advice is given by Jesse Livermore, as reflected more recently by Paul Tudor Jones:
“…I am leery of traders who have never lost it all. I think that intense feeling of desperation that accompanies such a horrifically deflating experience indelibly cauterizes great risk management reflexes into a trader’s very being.”

With that admonition in mind, the more mathematically inclined might read the appropriate sections dealing with the concept of ‘theta,’ in “Applied Math for Derivatives,” by John S. Martin. (See in particular pages 337-40/Sec. 12.5.4). The author provides the equation for calculating decay, and provides illustrations, including graphs, depicting the non-linear aspects relative to option decay). Of course, there are any numbers of option text-books that discuss this subject.

My suggestion is that you get a “feel” for non-linear decay by selling a covered call against 100 shares of stock that you own. If that isn’t viable at the moment, pretend that you either buy or sell a call of a stock that interests you, and carefully study the theta-and total value-of that option for thirty days. Draw an intraday graph, and save your coordinates to plot on a thirty day chart. At the end of that time, compare your project with a graphical illustration in an options textbook. Again, theta is the term used to describe the time decay associated with option decay. Theta is presented as a negative number, such as -.25, which simply means that an option contract with said theta will decay at a rate of .25 per day. The rate of decay is a function of the square root of the option. So, the rate of decay, as we’ve noted, is not linear. As one might intuitively expect, a longer-dated option decays at a slower rate than an option set to expire in two weeks.

 Please remember, though, that you are attempting to isolate one component, for study purposes, and that interim fluctuations in the total price of the option will be a function of all the variables in the pricing model. In other words, you are attempting to learn about how the liver works, while recognizing that the other organs in the body are just as vital.


It’s probably reasonable to assume that most people, and particularly those with a degree of market experience, realize that time and risk are intimately related. Increased time in the markets translates to a greater degree of risk. Of course, market risk can be hedged.

But, given what we know about option decay, are there more refined ways to think about the design and implementation of optimal strategies? Can we actually apply some of the traditional concepts of game theory to portfolio or trading management?

This is a complex-and provocative-topic, and only a cursory perspective is offered at this point- given time and space limitations, but feel free to ask questions in the comment section below . But let’s begin by addressing an extraordinary fallacy that appears repeatedly in various financial blogs and articles. These articles are not academic papers by any means, but nonetheless, they probably do substantial damage to traders and investors. The fallacy referred to is actually a mixture of ‘post hoc’ homilies and inadequate training/experience of numerous financial pundits.

These fallacies include:
  • The selling of an option is a one-dimensional process by which the seller of a given option is “locked” into the results flowing there from;
  • Option pricing methodology invariably creates a so-called “zero-sum” event.
These are two quite superficial-and distorted comments that appear time and again when options are discussed, if not maligned-particularly by non-experts in the field. The above are somewhat interrelated. So, are options really a zero-sum proposition?

I think it more precise to simply state that there is an approximate symmetry, but only within an initial one-plane dimension. A zero-sum result is a consequence of staying within this one-dimensional plane. In the option universe, multiple dimensions exist. There are other reasons to discount the zero-sum perspective, which are beyond the scope and purpose of this article. However, if you realize that, in reality, the so-called ‘person’ on the other side of your option transaction is little more than a fiction, you begin to understand the real game.

The other person at the moment of this mythical transaction, is a computer ledger. The market maker must accept your bet and hedge accordingly. As an example, if you take $100 cash and deposit it in your checking account, does that mean that said $100 resides in your account? Of course not! Just as your bank deposit does not reflect the exact physical currency initially entrusted by you, so it is with any type of currency exchange. The real estate contract of purchase and sale, which is often used to explain options, is, as we noted previously, terribly misleading.

Complex option strategies form patterns and structures that change from moment to moment. Yet, in a complex, bounded structure, we may observe patterns that are orderly in space and disorderly in time and others orderly in time and disorderly in space. And because options are derivative instruments, virtually all patterns constitute a set of “Russian dolls”- that is to say, we expect to find fractals. Volatility, much like heat in relation to the boiling point of water, will represent a zone from a steady state (except for time decay), to a pattern that oscillates within the prescribed boundary. This boundary is pre-determined by the strategist. All points within the strategy set, and the impact thereof, are confined within this zone. Knowing the boundary limits allows for fine-tuning. It is the fine-tuning or adjustment alternatives, deployed at the right time, which can create a differential advantage over forces that appear random.


If we are short an option, we are not locked in to an unwanted assignment, should the market not be in our favor as expiration approaches. An option can be ‘reset’ much as one can turn over an hourglass, and the game can continue-so the concept of expiration is highly misleading, and compels the novice to abandon positions at a loss. In theory, the game has no end, and I’ve seen documented records where one persistent trader rolled out of a position for 2 1/2 years-finally winning the game. One way of thinking about this is to realize that a short option can always be reincarnated, whereas a long option, as it decays, will vanish from the universe forever.

Bear in mind that the purchase of an uncovered long option requires that an event occur. The seller of an option, as noted above, wants nothing to happen. In that regard, note as follows:
  • Buying an option requires one to know something the market doesn’t i.e. otherwise the market has presumably determined the correct price (e.g. merger, earnings surprise, etc.)
  • Buying an option also requires an informed opinion as to the elements that determine the price of said option, especially implied volatility (the value of an option can actually decrease even where the stock moves up).

Stopping Short Sales...Spectacular Stupidity

Although on vacation, the markets have been moving apace and I have been watching in between the sun, beach and pool. One item I noticed has compelled me to type an observation.
I never fail to be amazed at the reasoning of politicians and market regulators. I hear that short selling has been banned by Belgium, France, Italy and Spain.
Do they not realize that the process of making a short sale be it “naked” or “hedged” is an essential element in the functioning of markets. It is as though politicians and regulators believe that the chaos in the Euro Zone has been caused by markets and wicked parasites that dare to sell assets.
The market does require regulation, but even post 2007′s financial crisis the touch should be as light as possible. The market is the one place where capital can be raised quickly and efficiently and it is by far the best manner of establishing a fair value for any asset be it a corporate stock or a government bond.
Why have market participants unloaded exposures to struggling nations government debt or severely exposed banks, simply because governments have not managed their economic houses well and racked up far too much debt. Similarly, banks that armed with sophisticated risk control and book limit systems should have known better.
If ”CAVEAT EMPTOR” means anything it is that market participants go into investment decisions with their eyes wide open. Surely the folly of acquiring an asset without appreciating the mechanism and risk was learned in 2007-2009. Sadly it looks as though it was not because for too long European banks have continued to snap up debt from bankrupt nations whose national economic accounting is not to be trusted.
In the case of SocGen, they themselves issued a warning some weeks ago that they would struggle to meet street expectations. Clearly such a statement would warrant a reaction i.e. to sell off the shares…if the last few days have been tainted by unfounded rumour mongering then who ever has opened a short will have to buy paper back PDQ if the rumour is proven to be wrong. I agree that the spreading of falsehood is ndesirable and should be investigated. However, to announce a blanket ban of shorting is the wrong strategy.

The process will make the market less efficient and not permit a true and fait value to be established. Afterall if a bank such as SocGen has had the capital to stupidly invest in distressed periphery debt then why not buy up cheap shares on the CAC 40 and make a very public statement about doing so.
Next it will be that a European regulator decides that a crazy idea once floated by Barney Frank in the US has merit and that whenever an investment is made…the investor should state how long they intend to hold the position for.
When that happens, we may as well all pack up our portfolio’s.

Peak in panic at hand?

by Kimble Charting Solutions

Wat does panic/fear look like?

by Kimble Charting Solutions

A 20% rally in the 500 index?

by Kimble Charting Solutions

Gold Warning, Cyclical 34 Month Bull Run is About to End

Gold hit $1805 tonight in trading, a Fibonacci Fractal figure I gave out a few weeks ago as a possible top. We are close to a near term high in Gold and Investors should be trimming back positions on this run. Back as recently as $1600 an ounce I forecasted a run to $1805 for Gold using fractal and wave analysis and behavioral patterns, now that we hit that figure it’s time to update the cycle and where we are.

Here is the Chart I did at 1599 gold on July 22nd:

I have been a Gold Bull since November 2001, having conducted seminars for public employees on investing back then and advising gold mutual funds and gold stocks very early. I have talked in the past about a 13 fibonacci year Gold Bull cycle that will end around 2014, so there are still three years left in my opinion. However, gold does have peaks and valleys and has moved in very clear Wave and Fibonacci fractal patterns for years.

Given the history of how I have forecasted Gold, I am going to share my short term and moderately long term views on where we are in the up cycle which I expect to last 13 fibonacci years to 2014. Right now it is my opinion that we are completing a MAJOR WAVE 3 up in Gold from the 2001 lows from $300 an ounce. We have had a 34 fibonacci month rally since the October 2008 lows of $681 per ounce. Every Taxi driver, CNBC guest or analyst, and 200 Radio and TV commercials a day are blaring to buy Gold. This is how intermediate tops form.

The rough wave count is below:
Wave 1- 300 to 1030
Wave 2- 1030 to 681 (October 2008 lows)
Wave 3- 618- 1805 currently, 34 Fibonacci month cycle. *Likely high is 1862-1900*
Wave 4- Due up next… a multi month consolidation

It is my opinion that at the top of a Major wave 3 in Gold, that everyone should be univerally bullish, that gold radio and TV commercials would be all over the place, and that everyone on CNBC would be talking about and recommending Gold.
Sound familiar?

So the likely conclusion to this massive parabolic blow off top of Wave 3 is nigh. Most recently I upped my estimates to as high as $1900 per ounce with $1805 already here as of tonight, which was one of my figures by the way many weeks ago. Gold should under normal circumstances top between 1862 and 1900 per ounce fairly soon should the 1805 level not hold as a high. At that level we will be dramatically overbought. We are already running 15.7% above the 20 week moving average line which historically is about as high as Gold will get before correcting hard and consolidating. A final lift to the 1862-1900 ranges should lead to a fairly good sized correction to the downside designed to kick all the late comer Taxi Cab driving buyers off the bull’s back. With that said, at $1805 I would be trimming my position and or hedging my long positions aggressively.

Watch for a Maximum Gold top at 1862 -1900 per ounce and keep in mind 1805 is being hit tonight and that is a qualifying fibonacci fractal top as well. Investors should be trimming back positions and looking to re-deploy back into Gold at better prices. We could get a huge blow off top over 1900, but it would be very very rare if it happens.

Gold Loves A Sovereign Downgrade

Don’t look now, but the holdings of the SPDR Gold Shares ETF (NYSE:GLD) are now within shouting distance of the all-time high set back in June of last year, some 24 tonnes added to the trust on Aug. 8, with a net addition of more than 100 tonnes over the last month.

Of course, the Bank of China has also probably purchased 100 tonnes or more in the last month – they just won’t tell anyone about it until about 2014 or so.

As for silver, it appears to be parting ways with the yellow metal and, based on the plunging premiums being paid over at the Sprott Physical Silver Trust, that trend may accelerate. Over 20 percent just a few days ago, the premium dropped to less than 15 percent on Aug. 8 as the metal looks to have become untethered from gold and latched onto industrial metals that have been in a virtual free-fall lately.

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