Thursday, July 24, 2008

When and how do we know this thing is over?

I think we are in a watershed event that is going to lead to depression around the world, but even that situation will have an end. The Great Depression lasted 20 years, even though historians seem to gloss this fact over with nonsense about the New Deal and other socialist programs that basically were make work, survival programs and little else. But, even in that vein, one of the great bull markets in history occurred between 1932 and 1937, where gains were in the area of 400% on the Dow. What followed was a bear market that was also one of the worst. There was a difference then in the sense that they at least could debase the local currencies and leave gold for international settlement. That end of the game is over and the only thing left to do is move the currencies to zero as a solution. I doubt TPTB will allow that to occur, as it would mean everyone was bankrupt. Also, the impact of intentional deficit spending isn't new any more and won't have the impact it might have had then. the only solutions so far are to sustain prices and demand at unsustainable levels and massive resistance to let the situation finish adjusting and put the problems behind us, thus the heartburn might just turn into a heart attack.
The US is the demand for the world. Robert Rubin undertook this path in the late 90's in order to attempt to finish the Asian crisis and we forgot to stop it. Trade deficits exploded with the stock bubble, then florished with the housing bubble. It hasn't seemed to sink into the average Joe's head or the average analyst what impact this trade deficit going away is going to have on the rest of the world. This is demand fueled by credit from the US. It might be money loaned back by other countries, but the credit is made in the US and that system is reversing itself fast. I believe this mess has the capacity to balance the US trade deficit and there isn't 5 countries combined in the world that could replace the $600 billion or so in excessive demand that the US brought to the table and if there are, it is only due to the fact that the US is running deficits with them right now. This amount of credit would suck China dry in about 2 years. They won't be able to expand or maintain trade by shrinking the value of the medium of trade.
The idea of Peak Oil might turn out correct not because potential production has peaked, but because consumption has peaked. I think people now will be shocked to see how much less gasoline is used, how much less paper towel is used and so on and so on. Take away pricing pressure and you will soon see the shitcan the Arabs have put themselves into with all their financial commitments. India implodes and the financial backing in China disintegrates. Commodities collapse and the commodity exporting contries go with it.
It will be worldwide and the signs are already showing worldwide. One of signs of this will be oil and what is right now being viewed as a bullish development, the price coming down, is either a temporary respite or a sign that what I am illustrating is starting to occur. The price of oil in this area has been there too short a time to have caused much of the economic grief that has shown up on the scene and much lower prices would have to appear before there was any impact on the current conditions. Bullish or not, oil is a limiting factor on economic expansion due not to price but to supply.
If demand for oil is indeed falling and price follows, then at some price there will be a need to sell more oil, not less oil due to financial necessity. At what price does this occur? I am guessing under $70 and maybe under $55. Remember if you were there, that in 1980, we were never going to see oil at $13 again and yet we did on and off for the next 19 years. I think $55 is a much more substantial price than $13 was 25 years ago, due to the direction other assets are headed and the relative financial position of the exporters. It is also substantial in that instead of allowing consumers to keep there cash and pay down debt, it keeps the money in circulation and in bank accounts. The main reason oil prices are inflationary at this time is they keep the money coming, but the consumer can only send out so much before they are tapped.
I would guess the best way to tell that my prognosis is wrong is if the bull win enough rounds to keep this from occuring is that home prices quit falling and home starts tick up(this is probably a nonsense sentence, but I didn't know how else to write it and I hope you know what I mean in the form of demand). As long as these are inclusive of each other, this game is going to go on and it isn't a housing crisis to start, but a housing bubble. Without price increases, construction increases only prolong and make the problem worse. I think the other thing is that oil demand remains high. As long as the demand and price for oil are high, the bulls are still in the game, contrary to the news. The most bearish news right now is if oil keeps coming down. The bulls didn't need lower prices, they just needed a price where it would stop going up. I believe that if China isn't in full financial crisis by this time next year or apparently headed for it, depression will probably be avoided. I would watch to see how much it slips. A legitimate boom continuing in China probably precludes a depression, but I have to believe for the time being that China is booming toward over expansion that won't be profitable. There is a lot of money from around the world chasing Chinese assets that outsiders really cannot own. The return will be zero.
Now if you followed me closely, I might have made sense. But, if you got lost by your follow the press logic, you might be more confused than before I wrote this. I think most of us bears believe the US credit system has run its course and this will take down the world economy, but at the same time, we have our eyes on 2002. This time is different, as all the financial companies have impaired financial positions and there isn't any home equity left to leverage. The hedges are fully leveraged and before long there won't be a counter party to buy what they have to liquidate.

Friday, July 18, 2008

Is the bubble done?

I have speculated for about 2 years that the oil rally would eventually end at a fibonacci number, $89 or $144 as it has appeared for the past couple of years. For one, I had an idea that the rally had fallen short in 2006 and that the low 80's figure was going to be the high. That was until the financial crisis left huge amounts of money unattached worldwide and the market ran past $89 to about $100. That too was a potential top, but once oil ran past $110, it was clear it was going to the $144 area, where for the time being it has stopped.

In such a market, the high of $147 or whatever it was interday was about as close to $144 as one could expect. The next move, if we do in fact go higher will be $233.

I have become attached to these fib numbers due to my knowledge of the movement of oil over time. For a long time it was $3 a barrel, even when $3 was a lot of money. In the 1970's, it moved first to $5, then to $8, then to $13 where it stayed for about 5 years. When the Iranian revolution broke out, oil then moved to $21 and then in a 2 price system to $28 and $34, with the Saudi's maintaining the lower price. When oil broke, it always settled in the $13 range before rallying back to $21 for about 2 decades, with some runs to $34 during times like the first Gulf War and early in the 2000's. Thus we saw moves to $5, $8, $13, $21 and $34, making 5 total moves. This time we saw moves to $21, $34, $55, $89 and $144 for 5 moves. Does this mean we are done? I think there is a real good chance we are, as there is coming something that few will understand, the fact that inflation causes deflation.

Here is what I believe and I will maybe change this, but for now I am going to stick to what I believe is happening. For one, the bust in the CDO market created a situation where $400 billion wasn't recycled to from one account to another and instead was funded by the banks writing what amounted to hot checks, leaving the money to circulate. Of course, the Fed had no alternative but to cover these checks, as word got out in the Fed funds market that maybe lending to XYZ bank might be a bad idea. Everyone knew about banks like Citi, which clearly had worldwide influence as was probably too big to fail, but much of this is still out there. There was the run on Northern Rock and the implosion of hedge funds, including some run by Bear Stearns, but this was lost money. The bank of England covered the funds drawn from NR with $100 billion. All this money was left to follow the only game left, commodities.

What has happened in the last year is quite interesting. For one thing, much of the $400 billion has been absorbed by deflation. I will elaborate here to the point that hopefully you can follow what I am talking about instead of reading the headline inflation numbers, primarily because inflation and deflation are lagging and not forward. First, much of this extra money went to buy oil because the demand for oil was burgeoning and it was something that would clearly store and play down the road. Second, much of this money ended up or was already in SWF (sovereign wealth funds) and much of this money went to recapitalize many of the weak financials. In this case, money kind of disappears. They say we have written off $400 billion worldwide, so that pretty much accounts for the $400 billion that didn't get recycled.

We are now seeing a pretty violent reaction on the oil price run up. The bulls think this is good news, but oil is a huge market. If this is indeed a speculator driven price hike, then it is clear that there are some huge speculators stuck in positions. There is only one way that speculators could have driven this market higher for this long and that is to roll their own contracts. In order to get out of the current months contracts, they would have had to have taken delivery or rolled sufficient enough long positions forward to entice the hedgers to move their short positions forward instead of making delivery at a loss, thus both moving their liabilities forward. Now that the shorts might have the upper hand here, it is quite possible they are going to force delivery of product the longs aren't prepared to take. I don't know where this oil may be hidden, but I woudn't be surprised to see it suddenly appear in inventory either here in the US or overseas. The point is that if speculators are indeed responsible for this bubble, then there is oil somewhere unaccounted for and if it is hidden by the longs, then it is financed and it and the borrowed money must be liquidated. This is a financial disaster awaiting the hedge funds and you can bet that OPEC itself has forward shorts in this market.

Amaranth supposedly lost $6 billion on their failed gas corner. To understand the size of their position, one must realize that gas declined about $8 from peak to bottom and that Amaranth probably paid around $10 for most of it on average. Realizing they got out at between $6 and $8 and that 1 trillion feet of gas sells for $1 billion a dollar then one might realize how huge their position was. Figuring they lost $3 per MCF, they had 2 trillion of the roughly 3 trillion in storage. I was wondering for some time how gas was staying as high as it was in light of how large the supplies in storage were. There just isn't a lot of places you can hide natural gas. This may not be true for oil, as I suspect there are storage facilities around the world that could hold a billion barrels or more and it not be inventoried. Imagine if there were 1 billion barrels of oil out there that suddenly needed to be liquidated? Even if the figure were 200 million barrels, we would be looking at the US supply of crude sitting out there somewhere. The large exporting countries have to have massive storage facilities for no other reason than to be able to manage production and demand over time. Countries like Indonesia where there used to be sizable exports could have large storage facilities that they could rent to allow the hiding of oil. The Japanese trader who ran the copper corner in the 1990's supposedly had copper in warehouses in LA and other areas that was bought on the LME.

In any case, the market could actually have been true rather than rigged as I suppose and there isn't a hidden surplus. I find that highly doubtful, having watched the oil market for decades. But, it has to be either a rolled contract game or an actual taken delivery and hidden game where continued pressure is put on the market by very sizable excess contracts being taken to delivery points over and over again. If a corner has enough long contracts over what could be provided to the market, they can always exercise a few deliveries and the shorts have to buy their way out of the rest of them. This gives the appearance of making a huge profit, which is really nothing more than postponement of a liquidation of long positions. All buyers have to become sellers in speculation and visa versa.

Where I part company with the bulls is I believe this to be highly deflationary. For one, the bulls think the consumer game will go back to normal while I believe that those that could still spend kept spending while those that couldn't used the rest of their credit just to survive this oil price run up. Thus, they won't be spending any time soon, if forever. Thus we have had a forced inflation in the short run out of this speculation which will cease and now the world will run without the credit inputs of high oil prices. You can consume for as long as you have room on your credit card, which could be as long as they keep raising the limit or the payments exceed income.

I am watching the money supply figures and they have weakened over the past 90 days. Not a decline in M-2, but a very weak growth, which in light of $160 billion in stimulous checks and the extra money that has been injected into some account by the credit used to buy gasoline is pretty sorry. Where would we stand without the stimulous checks? Bernanke was making light of this situation and the bulls seemed to take it as a signal of the bottom. I take it as the first true recognition that we are in recession and that we went into recession with Santa Claus gifts from Uncle Sam, huge booms in exports and 2% interest rates.

What I see now is maybe another huge short opportunity for the financials. There are again statements to the effect that the bottom is in on housing. It is going to be a damn flat bottom if that is the case. Suddenly Europe is slowing down and China is clearly going to be next, as it is paying massive premiums on everything it imports and its exports are losing traction with its customers economies on the slide. I sense the financials get a good month of reprive and then are back in the dumps again, just as we saw back in March. In fact, we really got to June before the financials started getting the truth out once more. First time it was C getting new capital, then it was Bear being bailed out along with MBIA and Ambac and now it is the implicit being made explicit in regard to FNMA and FHLMC paper. This won't in any way fix the problem.

I would watch the money supply figures going into the fall. I have to believe that we are going to see poor retail results as the stimulous money dries up and the price of oil dries up credit card spending. If inflation indeed turns to deflation, the entire world game is up.

Monday, July 7, 2008

Where is the money going to come from?

Lehman came out today with a statement that FNM and FRE need a total of $75 billion in cash infusion to get through their current mess. I wonder how much Freddie and Fannie think Lehman needs. It isn't a matter of who has the $75 billion, but who is going to need Fannie and Freddie to produce more lending besides the Congress of the US? This isn't a $75 billion investment. The investment has already been made and it was clearly insufficient.

I continue to be a deflationist in the teeth of what appears to be raging inflation. All the stuff that is going up isn't necessarily stuff that the US is going to jump off the bridge if it goes up. Between oil and gas, the US produces near 20 million BPD equivalent, now selling for $2.8 billion a day. How many countries in the world have a $1 trillion economy, much less in one category? We haven't even touched coal or hydropower or atomic, just oil and gas. Corn is going up? Also a big US crop, in fact the US is by far the largest corn producer in the world. In any case, in the scheme of things, consumption of these products aren't rising much if at all in the US, only in the emerging world.

One thing is clear. The US consumer in his entirety has run out of the capacity to borrow more money. This doesn't mean all consumers are tapped out, but the ones that add to their balances every month are. A guy that charges up his card and pays it off every month is a convenience debtor, not a debtor in reality. Then again, how much monetary growth over the past 15 years can be attributed to these pay as you go debtors? How much of the current money supply can be attributed to the $3o billion a month extra being spent on gasoline alone? Figure half the people put their gas purchases on a card, due primarily to the fact that most don't carry enough cash with them to fill up entirely, there is $15 billion on average that exists just because gasoline prices are higher for those that pay their balances monthly. Those that can't pay monthlyare on their way to becoming prior consumers, as are those that are trying to live within their means and the pump is replacing their other expenditures.

Remember, the CRB is hitting China a lot harder than it is the US. It is hitting Europe especially hard as well and the weak dollar has to be hitting their economy especially hard. How does China sell a weak US economy with a low US dollar more goods? REMEMBER China has to get dollars to buy oil?

You guys that read my stuff around the web can point to this as evidence I have called a high in the price of oil. It might get to $150, as is widely expected, but the fibonacci's are lining up with the recessions and the drop in demand and all other items, as the $400 billion hot check is mopped up and put back in the bank as capital infusions. China won't be repeating their expansion of the prior few years any time soon. Neither will Dubai once they realize that they paid top dollar one more time. This is all going on due to the flow of dollars in their direction, not because they have some kind of economic miracle going on. Think they are going to abandon the dollar and let the Europeans fleece them next? No, they are going to go with what brung them as I think Yogi Berra used to say (might as well be Yogi, as he said about everything else).

We have heard rumors of recessions and estimates of recessions, but we haven't had a broken financial system recession like this one that is coming since the 1930's. The inflation that happened in the 1970's along with the bad recessions weren't because the financials were broken, but because the demand for capital credit was so high that interest rates had to shift with inflation. What are our capital interest rates today? Even before the Fed loosened, capital rates had trouble running above 5% on risk free money and 6% or so on top credit lines. This is market, not rigged money. What will it be when there is no demand to build box retailers and speculate on stock in China and India or buy GOOG or 10 houses to rent and become a millionaire in 3 years?

The problems are multifold. America needs a pay hike and they can't get a pay hike because the jobs are going overseas if Americans get a pay hike. So, we have fat cats that get their money out of small cats that are going into debt to line the pockets of the fat cats who went long the ABX then short the ABX and now pretty much have no ABX to fleece the small cats who are out of credit and if they aren't subprime, can't sell their small home any more to someone that is so they can move closer to the fat cats. So one group pays off their debts and pulls in their horns because they can't keep spending money like drunken sailors and keep their penthouses in Manhattan on Central Park. The other group can't borrow any more and loses their job at Walmart because they can't spend and borrow any more at Walmart. The autoworker who has been building SUV's loses his job because they don't need that many people to build the mopeds that the poor guy who had a subprime auto loan on an SUV is now driving due to the fact the repo guy got the SUV he can't afford to put gas in any more and can't sell.

I have understood for years that we couldn't have a real bear market without some kind of credit mess. At one time, I supposed that the bear market would cause the credit problems, but instead I have come to understand that it is the expansion of credit that causes the bull market and the credit problems that result and with the credit game over so is the bull market. The 1970's, even though inflationary and a bear market, really were a bull market after the inflation really started and as it subsided, took off and carried the bull to amazing heights. The problem was the necessary switch in money, as was the switch in the 1930's. What is going to be the switch this time that saves the market from deflation?

One think I am beginning to notice is the restaurants are starting to look bare and the DFW area is a better economy than most. The shine is off Starbucks. It will soon be off the cellphone game, the PC game and the AAPL game. We are about to see a decline in the number of Visa cards for the first time in history and a lot of people are going to be forced to cash. I think the fact that we are seeing some growth in cash outstanding from the Fed is evidence that folding money is being carried for the purpose of buying gasoline in ever greater dollar quantities as many don't have credit any more. The price of gas will decline, but with the decline won't go the availability of credit. If anything, it will cause a drop in cash balances.

I think we are about to see an amazing decline in credit availability. Kudlow for once had some guys that were hitting the nail on the head. Joe Bataglia (sp) and another guy who don't agree too often were right on the money while Kudlow, Dennis and some other guy were in just pretend the price is higher a few years from now and all will be okay, as there won't be any write downs. The point is that the banks have to have capital to expand the money supply and I doubt many want to go to jail for covering up insolvency for long. Come clean now and they are all standing under the same mess, a subprime game that is no ones fault because the rating agencies said the risks were good. The world is standing still while it runs in place faster and faster.