Floating Them Trillions
April 11, 2011
Good morning. The market was slow and virtually unchanged last week, with the SPY closing down a scant .28 at 132.86. The VIX was up slightly (.48) to close at a still relatively low 17.39. There was a little more movement in interest rates, with the 30-year bond rate up.15% to close at 4.63%. Commodities, however, were a different story, as virtually all of them rallied. Gold was up strongly, with the gold ETF (GLD) up3.2% to close at 143.66, and oil was even stronger, up 4.6% with the oil ETF (USO) closing at 45.15. Some of the other commodities, like corn and soybeans, were also up on the week, with the exception being natural gas, which can gain no upside momentum due to huge supply in the spot market. It sure is interesting as we go from Republicans to Democrats to Tea Party people that whoever we send to Washington will do nothing to promote the use of natural gas (which we have abundant supply) versus oil, even at the margin. I never thought I would even entertain the thought, but you have to wonder how functional our system of government can be going forward in a world moving from corporate influence to outright dominance of policy. Looks to me like government is becoming more dysfunctional and corrupt by the day, and I surely think I am not alone in thinking that among people that are patriotic to the core.
It used to be possible to write a column (the word blog was not invented) about trading and investing where the political influence (call it meddling, potential interference, actual interference, whatever) was not like an anvil hanging over the markets. One could actually talk about earnings, capital rates of return, products, etc. like they actually mattered (still do in the long run) instead of budget deals, European bail-outs, special tax deals for some, etc. Anyway, it is hard to enter any conversation now without someone launching a broadside against President Obama and the Democrats, or the Republicans, as a lot of people are sure things are messed up and are looking to point blame. I will freely admit that I voted for President Obama. At the time I felt he was very bright, had some of the same moral principles I hold, and maybe would put our broken foreign policy back in some order. I also was very worried that he was too young, too inexperienced, and had very few connections with anyone who ever held a job or owned a company. It was clear to me that he was years away from his “optimal” time to be President, and we had just endured two Presidencies of men that were younger and more inexperienced than they should have been in that job. My hope was that he would have time to learn on the job before being beset by crisis. That did not happen, and my worst fears have been realized. Despite what people say, his Presidency, in my opinion (maybe with the exception of the health care fiasco), continues to be marred by having too little change from his predecessor, not too much.
There has been no change from the weak dollar policy, which I believe was put in place deliberately by President Bush and his group of cronies as a way to have two wars and pay for them on the credit card. Devalue the dollar a little, and ten to thirty years down the road pay it back in deflated dollars. They were not the first to think of that, so hopefully they did not think themselves original, governments have been trying to do that for centuries. That is why currencies were historically tied to something of real value. Obama has taken the same idea; pushed out a bunch of social policies he can’t pay for, and has decided to further devalue the dollar to pay for those initiatives far in the future. Add to that a recession brought on by greed and excessive monetary liquidity (maybe part of the devalue the dollar mess) and you have a real problem, like now. So, due to inexperience you bring on a bunch of economists steeped in the history of the Great Depression (again people with very little practical experience) and their response is to save, not the Banking System per se, but the current institutions (like C, WFC, BAC, etc) by floating them trillions (or really any number imaginable), again to be paid for some day with devalued currency. It is not the change Obama has brought that has changed my opinion of him; it is the similarities (favor big business, tax people rather than business, bury the dollar and those whose wealth is in dollars, ignore obvious inflation, no anti-trust at all, use regulation to put the little guy out of business, same lobbyists up the same people’s butts), where is the difference between that and the Bush mandate? Sure, the style and personalities are different, but the winners and losers are still the same. What is the difference between Paulson and Geithner, or Greenspan and Bernanke, that is where the real policy is being set right now, not in whether people in D.C. get to use an education voucher (big item this past week in the budget debate)? I believe it was Paulson who gave Bank of America the okay to use the tax carry backs from Countrywide (against the wishes of Congress), while Geithner did the same thing to GM. Those breaks were worth more than the total amount Congress was fighting about all last week, yet no one in Congress will call them out on those decisions. How can they walk (or sit) with someone always stuffing something in their back pocket, or do they just have no core set of right and wrong to even let them know the lunacy of some of these decisions.
This Tuesday we will have a very interesting guest on “Stocks and Jocks,” a fellow named Mr. Seth Lipsky. He is the founding editor or the New York Sun, author of Constitution: An Annotated Guide, and has written a huge set of thought provoking articles. The one we will be talking about Tuesday is “The Floating Dollar as a Threat to Property Rights” and it is a fascinating piece. It basically traces the thoughts regarding and the history of paper currency in this country from the Coinage Act of 1792, and compares the historical thoughts versus the policies of the current (and maybe past) administrations. The conclusions (do not want to stop you from reading it or in listening on Tuesday) essentially outline the effects on real property (things of value you own and have built) and saved wealth (hours you worked for a certain number, or value, in U.S. Dollars) when the value of that stored wealth (the dollar) drops dramatically. Let’s just say a lot of people we know will not be winners.
Look at the discontinuities these policies, and peoples reaction to it, have already caused. We have seen inflation in commodity prices; both because of the inflation affect itself of the expansive monetary policy and in the issues brought about by disturbances to the commodity markets themselves. Let me use as an example the corn market. The corn market, like most commodity markets, is designed ultimately for two groups, users of the product and producers of the product, to be able to find price discovery and hedge themselves from future price swings. Kellogg makes cereal, they are not primarily a grain speculator, so they are normally interested in “locking up” future grain prices for ease in marketing, planning, whatever, so they are the natural buyer of corn futures in the future months. Corn farmers, also, are not primarily grain speculators. They are interested in growing corn, and if the opportunity presents itself to sell their crop in the future for a good price they would be a natural seller. All the other people in the middle, brokers, speculators, PTI Securities clients, etc. basically provide the mechanics and liquidity for that to happen. I love trading corn, but it is as a trader and for the short term, it does not hurt (actually helps) the underlying action between eventual supplier and end user.
Now enter some huge hedge fund or pension fund that says, “Hey, keeping our wealth in dollars is for idiots, we need to have a position in commodities which seem to “hold” value as the dollar plummets, as part of out “normal” investments.” I am not sure there is “room” in an efficient market for someone to want to “control” 100 million bushels of corn (pick a number) either by taking it off the market and storing it somewhere or in a perpetual futures position of that magnitude. Stock investments in companies are meant to be held for the long term, corn is meant to be used. Even though the Futures markets provide very efficient price discovery their total open interest usually reflects a small percentage of total use of that product, meaning that the Future prices could become more volatile and even distorted in the short run by these additional participants. So you could have, in the short term, increased commodity Futures prices brought on by Fund buying as a hedge against inflation. The case could be made that buying by “outsiders,” meaning hedge funds, pension funds, ETFs, in 2008 might have been a factor in extending the oil run up to $147, and maybe in the subsequent sell-off back to the mid $30’s. In the longer term things do come back to where they should be, but the swings may have been more pronounced than maybe they would have been. The point here is that people’s response to commodity inflation caused by a sinking dollar essentially adds to commodity inflation, causing a double whammy, at least in the short term.
So how do we trade it? It sure seems like, for last week at least, that those looking to invest in anything so as to not be long the dollar have lost some faith in the stock market and are concentrating on primarily the oil, gold, and silver markets. We are watching these markets very closely, because if things do not change we may have to think about these areas (as I said last week) as a long-term hold. As most can probably tell, it would not be my first choice. The trade is very crowded, and seems to be going way past (for oil at least) any connection with fundamentals and actually increased production everywhere but Libya. I think massive hoarding is going on by governments and others, and my first instinct would be to play for a retracement, then maybe a long-term position. Due to a total vacuum of political leadership (except for those that think that the administration would love $6 gas as a start to the green agenda) regarding energy I think this oil thing may continue longer than it otherwise should. With protection in place I would not be afraid of investing in the XLE in the upper 70’s, obviously would like it better lower. One continuing problem with committing funds here is the even more pronounced skew in volatility going out in time. In some ETF’s we would be paying mid-20’s volatility for our long puts and selling shorter-term calls in the mid-teens. Being on the wrong side of a volatility spread of that magnitude we would like to avoid at all possible. Unfortunately, not investing leaves us back in cash, which is paying nothing and losing value. It is not an easy puzzle to solve.
The current opportunity for retail traders (my clients) continues to be in the near term, and the total lack of fear reflected in the near term options. Like we said, the options show fear in the long term, not in the short. The trade here is in having a positive delta (long premium) position in the week the market decides to break out from this very slow period. Being able to pick that exact week is, as always, very difficult. The trick is to lose very little or even break even in the weeks that you are early. It is also important to do the positions small enough to provide staying power. I think we are very close to the market breaking out of this very slow upward (at a slower rate) pattern we are in, either to a break out to the upside or a lot of people wanting to take profits at the same time. Everyone is convinced that they will be privy to the change in policy of the Fed in time, and that they will be able to cover profits with time to spare. I will say I have never seen that happen quite so gracefully. If it happens in more of a panic we want to profit by that panic.