The Armchair Economist

The Gold Fear Index

2012-01-22T21:27:00.000-08:00

I recent read the excellent book The Collapse of the Dollar and How to Profit from It, by James Turk and John Rubino. There is some solid advice in the book on how to investing in gold and other hard assets.

One of the more intriguing charts in the book is something called the "Gold Fear Index". The formula is pretty straight forward. Take the current value of the gold that the Fed supposedly has in reserve and divide it by the total money available in the economy (M3 money stock). The Fed stopped publishing the M3 aggregate in 2006, so I had to find some alternative sources to bring the chart up to date.

Since the supply of gold remains more or less constant, the ratio of gold reserves to M3 serves as a kind of sentiment indicator related to the price (demand) for gold. When the fear index goes down (the amount of dollars in circulation is rising faster than the value of gold reserves) the implication is that people are willing to hold these extra dollars because they're optimistic about the prospects of the dollar and/or the economy. When the fear index is rising (which occurs when dollars are moving into gold) the implication is that people are worried about the dollar and the health of the banking system, therefore they're looking for an alternative store of value.

The index can be used to produce a buy signal for gold when the fear index exceeds its 21 month moving average and the moving average is higher than its previous month's average. The chart below illustrates this concept with the blue bands indicating buy periods.

The most striking thing about this chart is that the current fear index is relatively low compared to the recent price movement in gold. Considering that the M3 is currently 17 trillion, there is a lot of money that can move into gold very quickly. Based on the run up in 1977, we could see gold climb to $5,000/oz or more in the near future. This gold bull run has a long way to go before we reach bubble territory.

Sources:
M3 Money Supply: http://nowandfutures.com/key_stats.html
Historical Gold Price: http://www.gold.org/investment/statistics/gold_price_chart
You can download my spreadsheet here.

Standard disclaimer: I'm not an investment adviser and my blog could merely be the rantings of an idiot (for all you know). Do your own homework.

Major Currencies Priced in Gold

2012-01-20T12:10:00.000-08:00

Below is a table of gold's annual percentage gain since 2002 in the nine major global currencies. The more that gold gained in a particular currency, the weaker that currency is. All numbers are percentages.

As you can see, some currencies do better than others (when priced in gold), but all of them have depreciated (some faster than others). The Australian Dollar is consistently strong, appreciating 8-15% on average against the US dollar while paying 2.2% in dividends. Nevertheless, the Aussie lost 10% against gold in 2011, so you would have done better to hold gold instead.

Another interesting trend that jumps out at me is the business cycle caused by currency devaluation (inflation) which weakens the economy until it goes into recession. Of note are India and China that have tried to cool their economies to combat inflation. Whenever this situation occurs, you can expect an initial slow-down followed by a rapid rebound.

Looking at this purely from a FX standpoint, the Indian Rupee, Chinese Yuan (and dare I say the loathed Euro) look attractive relative to the dollar ... and because equities in these countries have a strong correlation with their underlying currency, it follows that it may be a good time to shift some money to these markets as part of your dollar hedge. Suggested funds are ICN, PHYS, PSLV, INDY, FXA, EWG and FXI.

The story with FXI is similar to ICN.

Standard disclaimer: I'm not an investment adviser and my blog could merely be the rantings of an idiot (for all you know). Do your own homework.

US dollar (USD); Australian dollar (AUD); Canadian dollar (CAD); Chinese renminbi (CNY); euro (EUR); Indian rupee (INR); Japanese yen (JPY); Swiss franc (CHF); British pound (GBP)

A 222 Year Prespective

2012-01-19T11:09:00.000-08:00

Was the 2008 financial panic the bottom, or is the bottom yet to come? A rise in yields would generally be bullish for Equities, but we have the Fed controlling the entire yield curve ...

Source: What Drives The Bond Market?
Chicago CFA Handout by Bianco Research LLC

Standard disclaimer: I'm not an investment adviser and my blog could merely be the rantings of an idiot (for all you know). Do your own homework.

Market about to turn higher?

2012-01-10T22:08:00.000-08:00

I came across an interesting study that charts the ratio of the dividend stocks (SDY) to the growth stocks (SPY). The pattern illustrates investor sentiment and therefore market direction. When dividend stocks perform relatively better than growth stocks, then investor sentiment is bearish and the S&P index drops. When growth stocks perform relatively better than dividend stocks, investor sentiment is bullish and the S&P index climbs. We appear to be entering a bullish period.

Standard disclaimer: I'm not an investment adviser and my blog could merely be the rantings of an idiot (for all you know). Do your own homework.

Update on Gold

2011-07-13T18:05:00.000-07:00

In two previous updates, I made the technical and fundamental case that gold and silver were a screaming buy. If you'd heeded that advice, you'd be sitting on about 6.5% gains for gold and 8.1% for silver. Not bad for a little more than month.

Gold generally goes into a slump during July and August, but it can break out early. It recently hit an all time high, which is bullish. I think silver will outperform gold.

Not much else to do in this elevator but ride it to the top. Don't get off until the Central Bank starts openly buying gold from the public. That's when we take on a new currency and the dollar is kaput.

P.S. - I laughed my ass off today when Ron Paul asked Ben Bernanke (in committee) whether or not gold was money. Ben looked like a deer in the headlights. After a long pause, he said no. Ron then asks him why central banks are buying up record amounts of gold and not diamonds instead? Again a pause, then Ben says it's tradition. Really? That's all this genius can come up with? It's no wonder all he knows how to do is print money.

Of course gold is money and of course Helicopter Ben would say it wasn't. It was money in this country as little as 4 decades ago. If Ben admitted it was money today, it would be like a snake oil salesman admitting that his concoction doesn't cure anything. Or maybe he thinks it's not money because you can't print it and drop it out of helicopters. That's the point, Benny boy. That's what makes it sound money.

P.S.S. - Ben, if you decide to drop gold coins out of a helicopter, give me a call. I have a catcher's mitt and a mask. Bring it on. Forget those crappy greenbacks. They're hardly worth picking up anymore. :)

Standard disclaimer: I'm not an investment adviser and my blog could merely be the rantings of an idiot (for all you know). Do your own homework.

The yield curve

2011-06-30T10:01:00.000-07:00

You've undoubtedly read or heard references in the financial news about the yield curve - i.e. terms like steep (normal), flat or inverted curve. The concepts are easy enough to understand, but I've never found such a nice tool as on StockCharts.com to visualize the relationship between the stock market/economy and the yield curve.

Click on the chart to launch a live version of it. Click on the S&P chart to see what the yield curve looked like at that point in time. Notice how the curve went flat and then inverted in 2008, right before the market crash. Also notice that the low end of the curve is very depressed right now, but we can clearly observe a normal curve today.

Major currencies priced in gold

2011-06-17T14:03:00.000-07:00

Below is a table of gold's annual percentage gain since 2001 in the nine major global currencies. The more that gold gained in a particular currency, the weaker that currency is.

As you can see, some currencies do better than others (when priced in gold), but all of them have depreciated (some faster than others). The Australian Dollar is the strongest, although it lost 14% in 2010 (but also pays a decent interest rate). Note which currencies were safe havens in 2008.

US dollar (USD); Australian dollar (AUD); Canadian dollar (CAD); Chinese renminbi (CNY); euro (EUR); Indian rupee (INR); Japanese yen (JPY); Swiss franc (CHF); British pound (GBP)

Paraphrasing Nassim Taleb

2011-06-05T11:05:00.000-07:00

In the U.S. the authorities have transformed private debt into public debt, which is particularly vicious because private debt destroys itself whereas public debt does not, except through inflation. (paraphrasing remarks made by Nassim Taleb at the Feb-2011 Global Investment Outlook conference. Nassim is a professor of economics at New York University and author of "Black Swan")

There could be no truer a statement in context of federal deficits which heap onto the pile of debt. The dollar will most certainly lose its purchasing power as sovereign debt is inflated away through the process of money creation (printing). Inflation itself is a major contributor to the wealth gap because it hurts the middle class, the poor and the elderly much more than it hurts the wealthy (who tend to keep their wealth in real assets which are a hedge against inflation). The so-called "underclass" will become ever more dependent on deficit-financed government handouts.

Thus the ongoing debt ceiling battle is about more than just taxes, spending, entitlements and the next election cycle. It's also about the greatest fleecing of America since FDR. The die has been cast; and what politician can resist the majority who now find themselves dependent on the largess of the treasury?

Good/Bad News: Housing

2011-05-18T13:47:00.000-07:00

Whether the news is good or bad depends on your perspective as a buyer or a seller.

In March, 1/3 of U.S. homes sold for a loss.
Home prices will continue to fall for a while.

US Homes Sold For Loss

US Home Values - Interactive chart

US Homes Increasing In Value

US Home Values - Interactive chart

Interesting reading (gold/silver)

2011-05-16T08:59:00.000-07:00

Forbes Predicts U.S. Gold Standard Within 5 Years (Human Events)
The Relatively Poor Performance of Gold Stocks (GoldSeek)
The Real Reason It Is Still Too Early to Bet Against Gold (Q1 Publishing)
Playboy Predicts the Future for Silver (SilverSeek)
Gold Foretold the Commodities Dip (Pragmatic Capitalist)
How to Play Parabolic Silver (SilverSeek)
What's behind the commodities boom (Zero Hedge)
Is the Free Money Party Over? (Q1 Publishing)
Public Opinion of Silver (BIIWII)

Three things to know about gold

2011-05-10T10:30:00.000-07:00

There are only three things you need to know about gold:

The national debt can not be paid off except by devaluing the dollar (which is inflationary).
The price of gold will rise if real rates are negative (interest rate minus inflation rate).
Buy on dips and don't sell until the Fed openly offers to buy gold from the public.^[a]

You probably won't get rich, but you might be able to protect your wealth from the kleptocracy.

Real Interest Rates = 1 Year Treasury Yield minus Annual Rate of Inflation
Data Sources: FRED, World Gold Council, InflationData.com

[a] "How will we know when the gold boom is near an end? We believe we have a contrarian indicator that will give us some valuable clues: it will be when the world’s leading central banks begin to publicly consider increasing their gold reserves. That’s a signal to sell your gold." -- Claus Vogt

Standard disclaimer: I'm not an investment adviser and my blog could merely be the rantings of an idiot (for all you know). Do your own homework.

Gun check please

2011-05-09T20:23:00.000-07:00

According to the FBI, background-check applications for firearms buyers are on a record-setting pace so far this year. "In this year's first quarter," Bloomberg News reports, "the FBI's Instant Criminal Background Check System processed 4.25 million requests on prospective gun buyers - up 16% from a year earlier." If the current pace continues, the number of "gun checks" would hit a seventh straight annual record.

Source: Bloomberg

Sell Bernanke Bucks, Buy Gold

2011-05-06T14:49:00.000-07:00

Gold and silver dropped a lot this week. Should you buy?

Here's the short answer: The Treasury is planning to collect $2.2 trillion in taxes this year, but spend $3.7 trillion. That means Uncle Sam can only cover 60 percent of his bills out of pocket and has to "borrow" the rest from the Federal Reserve (which promptly prints the money). Helicopter Ben Bernanke can't print gold, though, because it's honest money. Don't think of it as a precious metal. Think of it as a currency that is high in demand and can't be devalued. Check out Gainesville Coins. (I have no affiliation with them.)

Ok, now for the longer, more technical answer: Here is a %change chart for gold and silver. Mean Reversion Theory suggests that the excessively large upward swing in the precious metals will tend to revert to mean (especially the more volatile silver). As you can see from the chart, a %change of +1 or +2 std deviation will tend to correct -1 or -2 std deviation (return to mean).

As you can see from the following charts for gold and silver, the metals are near their mean reversion. It's a gift. Take the gift if you think there is little chance of the Congress resolving the deficit spending problem. Otherwise, hang on to your depreciating fiat currency and near 0% interest on savings.

Update 14-May-2011: Check out Adam Hamilton's analysis that suggests that the next buying opportunity for silver is in the $26-28 range and that the next top will be above $42/oz.

Standard disclaimer:
I'm not an investment adviser and my blog could merely be the rantings of an idiot (for all you know). Do your own homework.

Additional Reading:
Don’t Fear a Pullback in Prices, U.S. Global Investors.
What it Will Take to Truly Stop the Gold Bull, Goldseek.

The Wealth Gap

2011-05-06T10:18:00.000-07:00

Inflation benefits the wealthy (who can afford inflation hedges, such as real assets) but inflation hurts savers, the poor, and the elderly on fixed incomes. This is one of the major causes of the widening income gap between the rich and the poor. You won't hear this from the President, Congress or the Federal Reserve ... because they're all complicit in the monetary and fiscal policies that have caused the dollar to lose 97% of its purchasing power since 1912 (when the Federal Reserve came to being). Claus Vogt put it best in his book, Global Debt Trap, as he explains what happens to the newly printed money coming from the Federal Reserve:

"Someone is always the first to possess the new money and the first to be able to spend it. These first beneficiaries are the inflation winners—they enjoy an incalculable advantage, for they can make purchases on the market at old prices, before the new demand drives prices higher. However, those who are last in line to get the new money are the inflation losers, forced to pay much higher prices."

This is painfully illustrated in the following chart. Instead of proposing populist income redistribution (theft) policies, the Federal Government should stop destroying the dollar and stop manipulating interest rates! It's high time that the Federal Reserve be stripped of its monopoly on money. End the Fed.

Book Review: The Global Debt Trap

2011-04-30T16:57:00.000-07:00

Claus Vogt

The talk of a U.S. sovereign debt crisis is becoming more frequent these days. Is this just talk from the kooky fringe? If you believe the mainstream media, that's what you'd conclude, but when Claus Vogt speaks, you should listen. He was one of the very few who predicted the real estate crash, which is in the process of transforming itself into a sovereign debt crash.

This book is easy to read and understand (assuming you have at least a basic understanding of economics). Nevertheless, Klaus Vogt's use of Austrian economics will challenge the way you think, if you were taught the economics of Keynes and Friedman. He provides a clear explanation of how we got here, and how it will ultimately resolve. The logic is flawless. I highly recommend this book to anyone looking to protect their wealth from the misguided Keynesian policies of Federal Reserve and the Obama administration.

Click on the link above to find this book on Amazon, and buy a wireless or 3G Kindle while you're there. I was once a critic of e-books, but I really enjoy my Kindle. The money you save on e-books will pay for the Kindle very quickly. I recently bought Murray Rothbard's "Concieved in Liberty", for example, the four-volume hard cover = $385, the Kindle e-book = $10. Can't wait to dig into that set. I digress.

Returning to Claus Vogt's book, here are a few of my notes and quoted passages that I've highlighted and shared via my Kindle. I hope you find these as compelling as I did and purchase a copy of his book for yourself.

Inflation benefits the wealthy (who can afford property and stocks) but hurts the rest who can't. This is one of the major causes of widening gap between the rich and the poor.

"Someone is always the first to possess the new money and the first to be able to spend it. These first beneficiaries are the inflation winners—they enjoy an incalculable advantage, for they can make purchases on the market at old prices, before the new demand drives prices higher. However, those who are last in line to get the new money are the inflation losers, forced to pay much higher prices."

I've been waiting for the other shoe to drop; so many vacant, overpriced buildings in NYC.

"Another major sector bound to deliver spectacular corporate failures and headlines is the commercial real estate sector—and not only in the United States."

Is America heading toward totalitarianism where the state is ruled by a few billionaire elites who may not be so benevolent?

"What we’ve seen in the Western nations of the early third millennium, however, is neither an example of capitalism nor socialism. Instead, thanks to the policies aggressively pursued by America’s two central bankers of our era—Alan Greenspan and Ben Bernanke—what we have is an entirely unholy and unsustainable mix whereby profits may be private but losses are socialized."

This corrupted economic system is nothing more and nothing less than an extreme form of crony capitalism—a very unique kind of nepotism—that, if pursued, can ultimately only lead to a fate similar to that of Iron Curtain countries themselves."

"Central banks are monopolies under government guarantee, which have constructed a banking cartel around themselves. This system has little to do with free markets. Indeed, especially in recent years, central banks in capitalist economies have been, in many respects, akin to central committees in former communist economies, manned by individuals who owe their primary allegiance to the state."

On cognitive dissonance and the herd mentality:

" ... human beings are gregarious animals who can believe—and sometimes, must believe—almost anything, as long as they are part of a group that subscribes to the same viewpoint. It seems no theory or thought is too absurd to be accepted by vast numbers of otherwise thoughtful people. Fictions that few could ever believe individually are trusted implicitly within the shelter of the group. Individuals who otherwise might be totally rational are swept up into irrational groups that suppress and inhibit even the most basic of common sense."

Never forget that politicians do not create prosperity. They merely redistribute it. What governments can't get from its citizens willingly, it will coerce instead.

"The banking crisis of 2008 and the sovereign debt crisis of 2010 are not failures of the market, but rather the consequences of monumental failures in monetary policy. This central truth is rarely recognized in the media or policy circles. Wall Street and Washington portray the inflationists as monetary defenders, and the arsonists as the fire chiefs. Don’t let them fool you."

"March 18, 2009, marked a turning point in American monetary policy and, therefore, presumably for the global monetary order at whose center the U.S. dollar still stands. It was on this notable date that the Fed announced it would begin buying longer-term Treasury securities, heralding the direct monetizing of government debt—the final transition to direct inflation of the economy."

The year 2000 was the top for equity markets, in real dollar terms. It's not too late to get into the precious metals market. The end game is unloading your gold at the top and to putting the proceeds into other real assets.

"We repeat: the key prediction of this book is that by perpetuating and deepening the global debt trap, governments are guaranteeing a further dramatic acceleration of the global financial and economic crisis over the coming years. As a consequence, we regard it as highly probable that the next decade will see very acute changes and upheavals."

"In the long term, we anticipate a renewed commodities boom that could put previous commodity booms to shame. However, over the course of the coming two years (2011 to 2012) we anticipate an intensification of the global economic crisis, which will likely delay the start of this boom."

"How will we know when the gold boom is near an end? We believe we have a contrarian indicator that will give us some valuable clues: it will be when the world’s leading central banks begin to publicly consider increasing their gold reserves. That’s a signal to sell your gold."

Debt Saturation

2011-04-27T20:51:00.000-07:00

Source: http://www.gordontlong.com/

Cognitive Dissonance

2011-04-25T20:37:00.000-07:00

The most interesting thing about this video is the counter-intuitive results. The person who got paid $20 had enough incentive to lie to someone else, but they didn't need to deceive themselves first (about the test being interesting). On the other hand, the person who got paid $1 had to actually lie to themselves first, before they could justify lying to someone else for a lousy buck. Fascinating. The implications for behavior finance should be obvious.

Chinese housing bubble?

2011-04-14T10:39:00.000-07:00

Cognitive dissonance occurs when the mind entertains two conflicting thoughts at the same time; one thought is considered true and the other conflicts with that truth. This occurs often in the investment community and in economics. More times than not, the discomfort is resolved by ignoring the new data. This is one of the ways the market fleeces people of their money and why central banks are so often wrong.

Ok, what does this have to do with the Chinese housing market? Well, I once was told by a friend that I was crazy (or ignorant) to think that the Chinese housing market was a bubble in the making. All those ghost towns in China were mere mirages and propaganda perpetrated by bitter Americans ... and besides, on aggregate, America has more empty homes than China. One small problem; recently, Beijing experienced a 27% drop in new home prices ... IN ONE MONTH! Oh, the discomfort.

How will my friend resolve his cognitive dissonance? My advice ... click your heals together three times and repeat over and over ... "there is no bubble, there is no bubble, there is no bubble ... "

Update 15-Apr-2010: Oops! Moody's downgrades China property sector to negative.

Classic Bubble (update)

2011-04-13T13:19:00.000-07:00

In a previous post, I compared recent home prices with classic bubble behavior. If you consider that the bubble rise (X) was about 6 years from 2000 to 2006 (A), then the time down (Y) would be another 6 years (B). That places the bottom at around the end of 2012 or so (if we don't overshoot the mean).

The reality is probably like the chart below, which is pretty sobering. That little bump in 2009 was due to government's ill conceived tax incentives (first time homeowner credit). What this means is there is a long slog ahead in clearing out delinquent mortgages and that banks are not out of the woods yet. Another precipitous plunge in home prices can set off a wave of new bank failures. Hold on tight.

Created by Steve Barry, originally published at The Big Picture

The shocking truth

2011-04-10T08:56:00.001-07:00

Near the end of this video is the shocking truth that most Americans don't get. Everyone is trying to game the system ... the lower 50% who want to take from the rich ("share the wealth") ... and the wealthy who can protect themselves from the Fed's money printing (because they can own real assets and transfer their wealth to other currencies). Which class do you think will win?

The end game is the raping of retirees and the middle class of their savings and a collapse of the wealth transfer system (including for those who are truly needy). The more the Fed prints, the poorer we all become (but the wealthy know how to protect their wealth from confiscation).

Got gold?

Hyperinflation

2011-03-18T20:39:00.000-07:00

Courtesy David Dees illustration Studio

Of the 29 hyper-inflationary episodes (where significant data exist) every episode looked the same. “Hyperinflations are always caused by public budget deficits which are largely financed by money creation ... the figures demonstrate clearly that deficits amounting to 40 percent or more of expenditures cannot be maintained. They lead to high inflation and hyperinflation ... Hyperinflations are not caused [solely] by aggressive central banks. They are caused by irresponsible and profligate legislatures that spend far beyond their means and by accommodative central banks that lend a helping hand to governments.” ^[1]

The federal government has run a deficit far in excess of 40% of revenue since 2009 (blue line below, left-hand scale).^[2] That's profligate! Note that the deficit troubles began about the time Nixon took us off the gold standard in 1972 (red line, right-hand scale).

Source: FRED® (Federal Reserve Economic Data)

The Federal Reserve recently funded the vast majority of new federal borrowing in the 4th quarter of 2010.^[3] That's accommodative (graph below). Note that both foreign and domestic buying declined.

Source: FRED® (Federal Reserve Economic Data)

Are we in danger of a hyper-inflationary episode? Maybe the better way to word that question is: How likely are we to experience a hyper-inflationary episode if the government is operating under a balanced budget? I think it's time for the President and the Congress to grow a spine. It's time to balance the budget.

References:

[1] Professor Bernholz, Monetary Regimes and Inflation: History, Economic and Political Relationships, retrieved from Pragmatic Capitalist, Inflation and Hyperinflation.

[2] FRED® (Federal Reserve Economic Data), retrieved from Economic Research, Federal Reserve Bank of St. Louis.

[3] The Big Picture, Is This Why Bill Gross Dumped Treasuries?

ARRA

2011-03-12T20:46:00.000-08:00

Did the American Recovery and Reinvestment Act (ARRA) stimulate the economy or create jobs? We were told that we must pass the stimulus bill or "experience a crisis unlike any we have seen in our lifetime".^[1] We were also told that unemployment would be much worse without the "stimulus". Now we're two years into the "recovery", so let's check on progress.

So what do we have to show for the near 1 trillion in "stimulus"? Where are the jobs? Where then did the money go? Paul Krugman has the answer, as illustrated in the chart below.^[2]

In essence, there is no change in the trend of government spending after subtracting the state budget cuts from the increased Federal "stimulus". Did ARRA really "stimulate" the economy? No. What did we get for the money? A larger government! Heap on more regulation and onerous healthcare legislation ... and walla! More jobs! Not!

References:

[1] Obama: Swift Action Required to Restore Economy, Wall Street Journal, 9-Jan-2009.
[2] The Great Abdication, Paul Krugman, New York Times, 14-Feb-2011.

A nice ride on MSN

2011-03-04T10:06:00.000-08:00

I discovered this micro-cap during my FROIC research and bought 10,000@2.06 in December. I liked the stock because it had good cash flow and was pessimistically priced. The stock is up 43% now after the Feb-14 earnings announcement, going ballistic, despite the market sell-off. I have a trailing stop, but may sell soon due to the fact that this stock is thinly traded. Sometimes a small bet pays off handsomely.

Update 07-Mar-2011: Sold at 2.92. Stocked dropped 6% an hour later. That was close.

Train to Brokesville

2011-03-03T15:39:00.000-08:00

Have you ever wondered why the U.S. Mint doesn't use precious metals in circulated coins anymore? It's because the value of the metal would exeed the face value of the coin. People would hoard them, or even melt them down for the silver, copper or gold. It takes about 36 of today's zinc quarters to buy the amount of silver contained in a 1964 quarter. It's a sober statement about the ever-declining value of the dollar (which has lost 95% of its purchasing power since the Federal Reserve was established in 1913). Criminal!

I recently purchased a modest stack of Silver Eagle Dollars as one of those rainy day, unlikely disaster scenario hedges. They have gone up in value by 75% since I purchased them a year ago. The mint can't keep up with the demand for Silver Eagles and has run out of silver blanks. This speaks to the flight to quality, away from the dollar.

I wonder if the phenomena is also a sign of the times: "A quart of wheat for a denarius, and three quarts of barley for a denarius." (Rev. 6:6) A denarius was a days wage for a laborer in the 1st century, and a quart of wheat was a days food ration. Today, people in much of the world spend between 40-70% of their income just to feed themselves, so it seems that we're not far from that prophesy. Nevertheless, you don't have to believe in prophesy to see the rapid devaluing of the currency and the precipitous rise in the cost of food. A lot of this has to do with supply and demand, but a lot of it is due the fact that the dollar isn't real money anymore.

It's been nearly 80 years since the U.S. stopped using gold coins as legal currency, and nearly 40 since the world abandoned the gold standard, but the precious metal could be making a comeback in the United States -- beginning in Utah. Legislation is pending vote in Utah that would recognize gold and silver coins issued by the federal government as legal currency in the state. Twelve other states have offered similar proposals: Georgia, Montana, Missouri, Colorado, Indiana, Iowa, New Hampshire, South Carolina, Tennessee, Washington, Vermont and Oklahoma. If this isn't a sign that people don't trust the currency, I don't know what is.

It's no wonder when the billion is the new million, and trillion is the new billion. Everyday I hear or read billion and trillion dollar figures thrown around as if they were mere pittance, but only if we're talking about government deficit spending. If we're talking about cuts to the Federal budget, then billions suddenly become some astronomical number and a terrible hardship if cut from the budget. It seems that the government critters know it's all going down the crapper, so they spend like there's no tomorrow ... get while the getting is good.

I fear the dollar is going the way of the Weimar Deutschmark or the Zimbabwe Dollar. We're on a slow freight train to brokesville.

Transports slowing (Dow Theory)

2011-03-02T05:13:00.000-08:00

West Texas crude went up another $2 today, exceeding $100/barrel. Brent crude is more than $115/barrel.

The precipitous rise in oil prices is affecting the Dow Transportation Index, which is important to those who follow the Dow Theory. The theory is simple. If the transports take what the industrials make, then both go higher and the bull market is confirmed. If you don’t get that Trenton Bridge effect (if industrials and transports diverge), then it's time to raise a caution flag.

The zig-zag (in the chart below) is the ratio of the transports over the industrials. It should follow the general trend of the stock market. As you can see, the transports are heading into a slump (due to the rising cost of energy)

Update 30-April-2011: The Transports seem to have recovered from their Feb/Mar slump, despite high oil prices, and the DOW is on a tear again (on higher volume).

Gold reaches new high

2011-03-01T13:56:00.000-08:00

Gold flew into the stratosphere today, climbing to $1,436/oz as tensions ratchet up in Tunisia, Morocco, Algeria, Yemen, Oman, Libya, Korea, China and Iran. The DOW made an orderly decline of 1.6% while the dollar and treasuries gained only slightly. There wasn't a flight to the dollar or treasury bonds that typically accompanies a market sell off. It appears that gold is the new safe haven, or is it?

Could this be the next big leg up for gold, or is this a temporary phenomena caused by fear? How much of the rise in gold is due to demand and how much is due to the declining dollar? One way to answer that question is to look at the Kitco Gold Index (annotated below).

As you can see from the above graph, the actual demand for gold (using a basket of major currencies) is far less than the dollar value of it. The demand trend (blue) doesn't look as bullish as the dollar trend (red). Whether gold continues to climb or not may depend on if the dollar becomes a safe haven once again (or perhaps the least ugly of the bunch).

The graph below is inconclusive; the dollar could go either way in the next few weeks. I think the odds are that the dollar will rally again, putting downward pressure on equities, gold and commodities. If not, we may be in for some fireworks. I take the contrarian view that there are too many people betting against the dollar. There's a big potential for a short squeeze.

The next powder keg?

2011-02-12T23:16:00.000-08:00

In researching the fuel/food/Fed connection, I had a "duh" moment when I realized that the flash-point countries all have something in common; a lack of economic and political freedom. The vast majority of them have government controlled economies, very little economic freedom, little or no property rights, and rampant corruption. These regimes can exist only so long as they are able to feed and employ their people. The recent economic downturn and currency debasement is taking its toll on these fragile regimes, turning the people against their governments.

Update 16-Feb-2011: Protests broke out in Lybia. It was way down on my list because it's a rather sparsely populated country. I moved it up closer to the top.

It's not clear what the inflation rate is in Lybia, but food costs are rising quickly. The Lybian gov. wants OPEC to raise the price of oil to $100/bl to help pay for rising food costs. The irony is that higher energy costs cause higher food costs, so this plan might actually be self-defeating.

Update 17-Feb-2011: Added Bahrain to the list as protests break out. This wasn't even on my radar considering that people seem able to feed themselves and the standard of living is comparably high and the people comparably more free.

One of the U.S. allies in the region with a major U.S. military base. Unemployment is 15%, food costs are 29% of personal spending. Petroleum production and refining account for 70% of government revenues. Net oil exports are approaching zero. Friction caused by majority sect being ruled by a minority sect.

Update 24-Feb-2011: Fuel prices raised 24% in Vietnam by the autocratic government. Unemployment is 6% and they are able to produce enough food to feed the people, so they have that going for them. Unfortunately, inflation is 11% and food is 61% of personal expenditures. They've had unrest their in the recent past.

Update 26-Feb-2011: Oman sees unrest. Protestors asking for jobs, democracy and to get rid of corrupt administrators.

Update 20-Mar-2011: Events coming too fast to keep track. There is an interesting interactive graphic on the WSJ that is helpful.

Sources:

Index of Economic Freedom
The Economist Intelligence Unit’s Index of Democracy 2008
FAO list of Low-Income Food Deficit Countries (LIFDC)
FAO Food Price Index
CIA World Fact Book
Energy Export Databrowser

Are you financially literate?

2011-02-09T19:55:00.000-08:00

It's a bit shocking that 73% of adults between age 23 and 28 could not answer 3 out of 5 of these questions correctly. Can you?

Q.1) Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?

A. More than $102
B. Exactly $102
C. Less than $102
D. Do not know

Explanation: If interest was only compounded annually, the amount in the savings account would be $110.41 after five years.

Q.2) Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After 1 year, how much would you be able to buy with the money in this account?

A. More than today
B. Exactly the same
C. Less than today
D. Do not know

Explanation: In this example, a $100 savings account would have a value of $101.00 after one year, but because of inflation its buying power would only equal $98.98 in today's dollars.

Q.3) If interest rates rise, what will typically happen to bond prices?

A. They will rise
B. They will fall
C. They will stay the same
D. There is no relationship between bond prices and the interest rates
E. Do not know

Explanation: For bonds previously issued on the open market, bond prices typically move inversely to interest rates. When interest rates go up, bond prices generally fall.

Q.4) Please tell me whether this statement is true or false. A 15-year mortgage typically requires higher monthly payments than a 30-year mortgage, but the total interest paid over the life of the loan will be less.

A. True
B. False
C. Do not know

Explanation: On a $100,000 mortgage at 5.00%, the 15-year term has monthly payments of $790.79, total interest paid $42,343. The same mortgage over a 30-year term has monthly payments of $536.82, but total interest paid is $93,256, over twice as much.

Q.5) Please tell me whether this statement is true or false. Buying a single company's stock usually provides a safer return than a stock mutual fund.

A. True
B. False
C. Do not know

Explanation: Stock mutual funds are designed to lessen the risk of owning individual stocks by diversifying investments across many stocks and through the use of professional fund managers.

The fuel/food/Fed connection

2011-02-09T12:15:00.000-08:00

Below is a graph of the spot price of Brent Crude next to the FAO Food Price Index (via Bloomberg). The clear correlation is not surprising considering that it takes approximately 7 to 10 calories of energy to produce 1 calorie of vegetable food, and 35 calories of energy to produce 1 calorie of meat food. A lot of that energy is used to power farm equipment and to transport food all over the planet, but a lot of fossil fuels go directly into making fertilizer. As the price of energy increases, so also does the price of food. (continued)

Add to this the U.S. subsidized conversion of food into bio-fuel. It's crazy to use so much energy to produce food just to turn around and use the food to create energy. Such is the so-called "carbon neutral" myth of ethanol and bio-diesel. It's just one more example of big business using big government to screw tax payers. This type of idiotic policy only worsens the problem by adding to food and energy demand.

The percent of income spent on food is rather small in America and has been shrinking for decades. This is not the case in other parts of the world, as you can see from the interactive map below. Many of these countries peg their currency to the dollar, which exacerbates the problem of increased food costs (as the dollar is systematically devalued by the Federal Reserve). Many of the unstable hot spots in the world have very high food costs (as a percentage of personal expenditures). Thus we have a direct connection between U.S. domestic food, energy and monetary policy and instability in other parts of the world.

Food Costs as a Percent of Total Personal Expenditures

Click on the above image to launch a full-screen interactive map. Source: USFDA Economic Research Service

Euro Crisis

2011-02-05T19:14:00.000-08:00

At first, I missed the significance of this brief note from Mises. Ireland is now printing 25% of its GDP in Euros, completely naked (unbacked). Normally, the gov. borrows money. In this case Ireland is not borrowing the money, but simply printing it (adding a bunch of zeros to the end of bank balances). Isn't this a prelude to hyperinflation in the Euro?

Knowing something about German history, I can not imagine a worse nightmare for the German people than to have their currency diluted on demand by reckless neighbors. Irish banks owe hundreds of billions to German banks, which they will now apparently pay back in freshly printed Euros.

Food security

2011-01-28T11:34:00.000-08:00

This is a follow-up to a previous post (June, 2010) in which Bloomberg reported a bearish commodities signal. Below is an updated Jefferies CRB index of 19 major commodities. Notice the reversal of trend near August as speculation increased that QE2 would be announced.

In August, 2010, the Fed announced additional quantitative easing (dubbed QE2, which is a fancy term for "printing money"). QE2 was meant to increase asset prices (so that people feel more wealthy and spend again). At the time of the announcement, the S&P 500 was down 3% for the year. From that point forward, the S&P rallied 19%, oil went up 16%, copper +32%, coffee +34%, corn +43% and cotton +57%. These increases manifest themselves soon thereafter as higher energy, gasoline and food prices etc. Are you feeling wealthier yet?

The increase in commodity prices are further illustrated by the USDA data for agriculture, livestock and retail food prices. At first, food producers covertly increased prices by shrinking their product packaging, but more overt retail price increases are now showing up.

Source: USDA Economic Research Service, Normalized Prices

Source: USDA Economic Research Service, Food CPI

As you see from the above charts, prices rose dramatically in 2010. The Fed's dangerous game is causing food shocks, protests/riots and the overthrow of governments (many countries peg to the dollar).

Can food shocks and a state of unrest occur in America? I didn't think so, until 2008 when oil hit $140/barrel, aviation gas hit $6/gallon, auto gas hit $4/gallon and my food and energy bills really started to take a big bite out of my wallet. There were food riots in numerous parts of the world in 2008 (it seems that we learned nothing and are back in the same precarious position two years later). This really caught my attention at the time, and so I did some research to understand whether or not this sort of thing could happen in America.What I discovered was frightening.

So much of our food is imported, shipped to us from all corners of the world and controlled by a handful of multi-national companies. Our centralized food supply chain is quite vulnerable to disruption. We have no national food reserves, like we do with crude oil and refined fuels. Grocery stores have at most 3 days of food on hand. Most people have a week's worth (at most) of food at their homes. We've all seen how an approaching hurricane or winter snow storm will cause people to empty a grocery store in mere hours. I shudder to ponder what would happen if something worse than a snow storm occurred (Katrina).

It was common place, 50 years ago, to store weeks or months worth of food in a home pantry, to have a small garden and to put away an autumn harvest into bottles. We have become so accustomed to always having every variety of food at any season, that we simply stopped storing food at home. Food has been so cheap for so long, that it simply stopped being economical to grow your own in the backyard. Local sources of food have dwindled as a consequence.

How long before the average family starts to go hungry after the grocery store is emptied, after a run on the bank, after a currency crisis, or a natural or man-made disaster? 3 days, 1 week? How long before we see riots and looting? 1 week, 2 weeks? How long before we see armed bands of pillagers looking for food? 3 weeks? Can you protect yourself? Do you have a defensive weapon? Can you hit the broad side of a barn with your weapon?

No, I'm not an alarmist or a fear monger. I'm a keen observer of the foibles of people, of socioeconomic patterns and of the market trends. Food security is becoming a more frequent concern and the vast majority of Americans are ill prepared for a disruption in the supply. Our political environment is very fragile and it wouldn't require very much of a push before your fellow American is turning on you. One would be a fool to think his countrymen were any different in nature than those half way around the world in Africa, the Middle East and Asia. People are people.

So how then are we to protect ourselves and our families from a food shock? Can we buy food insurance? Yes, we can, for about $100/person/year. That's pretty damned cheap, if you ask me. Where can you get a food insurance policy? You can't. You have to store food. It's really not as difficult as you might think (see list of links below). In addition to food storage, secure a local source of food by joining a farm cooperative (these exist even in the Big Apple).

We all hope never to experience a food shock, but having personal food security is worth the peace of mind, if for no other reason. If you wait for a disaster before you prepare, it will be too late.

FEMA Disaster Preparedness: Good information for short-term disaster preparedness (up to a few weeks). Worth a read.

Survival Acres: It sounds like a provocative name, but these folks have an honest price and honest business practices. A recent surge in demand has increased the lead-time to 8 weeks. It seems people are starting to worry about food security and are doing something about it.

All Things Emergency Prepared: A good do it yourself resource with lots of storage materials and information, including sources for diatomaceous earth.

COSTCO: Even good ol' COSTCO is riding the trend. The prices seem very good, until you look at the calorie count. Be sure to order enough food to eat normally.

Emergency Essentials: Their one-year combos are light on calories, but the selection is good if you're looking for smaller quantities.

Nitro-Pak: Freeze dried foods that last a very long time, but also a lot more expensive than dehydrated foods.

Bulk Foods: A great source for do-it-yourself food storage. Excellent quality, selection and price.

There are a lot more sources out there and they aren't very hard to find.

Update 28-Feb-2011: All the major food preparedness companies - Nitro-Pak, Mountain House and Survival Acres are all reporting very high demand. Costco still has stock. It may have something to do with a massive FEMA order.

Classic Bubble Behavior

2011-01-25T08:41:00.000-08:00

Check out the Case-Shiller Residential Home Price Index compared to the classic bubble model. It suggests that 2008 was the bottom, but we're in for a little more pain before the housing market stabilizes. (click each chart to enlarge)

Selling FROIC Alpha positions

2011-01-21T18:22:00.000-08:00

The Chinese Yuan is about to be revalued, causing an initial panic sell of equities (or an excuse to take profits). It will be a short-term phenomena. In the long run, the revaluing of the Yuan is very bullish for equities as it will cause China to export its inflation to the U.S. This will cause interest rates to climb and the dollar to drop in purchasing power. At that point, investors will flee bonds into equities again and we're off to the races again.

It's a reasonable hypothesis put forward by more than a few, but whether or not it pans out, the market is just way too bullish with ridiculous, edgy swings in mood. The $SPX is very over-bought on the weekly chart. I don't like the divergence in the Baltic Dry Index either. $VIX futures are signaling rough waters ahead. I'm mystified by the way the $SPX defies the summation index.

I could be completely wrong, but I just "feel" like a contrarian, and therefore bearish, so I'm taking my money off the table for a while (as each item in the portfolio looks toppy). I'm already 10% ahead of the $SPX (on a risk-adjusted basis) and 5% ahead on total value ... so I sought alpha and I found it. Making 50K on 250K investment in 6 months (using no leverage) is nothing to sneeze at. FROIC investing works, but I don't want to be a greedy bull and overstay my welcome.

When gold and silver are done with their healthy correction, I'll put my play money into precious metals, mining/natural resource stocks and agriculture commodities. Inflation, here we come.

Dead cat bounce!

2011-01-14T11:51:00.000-08:00

How many times can a dead cat bounce? Three bounces (so far), judging from this chart of a municipal bond ETF. What does that tell us about investor confidence in municipal bonds?

Bonds are supposed to be as boring as watching grass grow, but municipal bonds are getting punished by investors. This bond fund dropped 12% in three months! No wonder, with states and cities cutting back on services, unable to pay their bills and digging themselves into a deeper hole. The Feds are paving the way for defaults, rather than bailouts. It's not exactly building confidence.

Click on the chart to view an interactive version (new window).

Update 15-Jan: Here's an interesting article that touches on the debate whether the ETF market is causing the volatility in the muni market. On the one hand, an ETF of oft-traded bonds may be a better vehicle of price discovery than an index containing rarely-traded bonds, but one should not ignore the fact that municipalities and states alike are going bankrupt.

Profiting from peak oil (part II)

2011-01-06T21:15:00.000-08:00

Continuing this theme from a previous post, I wanted to look at why most of the natural gas producers are cash flow dogs. As it turns out, the break-even selling price of gas is between 3.25 and 5.25 dollars (depending on the producer). As you can see from the graph below, that's the range where the price of gas has been for the last two years. Historically, the price has been in the much more profitable range of 5.50 to 8.50, but that was before producers found a way to dramatically increase production using a process called "fracking". The producers have only been able to make up the lost profits by increasing volume (which is why the mid-stream segment - the pipeline, storage and processing companies - are making money, hand over fist).

Where's the price of natural gas going? Look at this chart first. My comments continue below.

The first thing I want to bring to your attention is the divergence of the price of oil (line) and natural gas (solid area). Notice also that the spread between these two prices is illustrated by the oil/gas ratio at the top of the graph. This ratio has historically been in the 10 to 11 range, whereas you can see that it is nearly double that now. What this suggests to me is that as energy demands increase (domestically) the oil/gas spread will decline. Here are some possible precipitating factors:

Oil will drop in price, or natural gas will increase in price (or both).
Drillers will switch to more profitable oil, thereby reducing the supply of gas.
Regulators will restrict "fracking" (due to water contamination), reducing supply.
Natural gas producers will start to go out of business, thereby reducing supply.

One way or another, the oil/gas ratio will decline, thus it seems a good bet that natural gas prices will return to a normal profitable range again. The question is how to profit from producers?

As mentioned previously, the natural gas producers are mostly cash flow dogs with huge piles of debt, so I'm not thrilled about investing in these kinds of stocks. It's something to re-evaluate later, however, when natural gas prices go north of $5.50 again.

Another possibility is to buy natural gas futures through the United States Natural Gas ETF (UNG). The problem with this approach is a condition known as contango, which is a peculiarity of commodities futures. This causes the ETF to track poorly to the underlying commodity.

For now, the best bet is probably the large integrated majors, Exxon (XOM), Chevron (CVX) and Occidental (OXY) having some of the best cash flows. Conoco (COP) and CNOOC (CEO) are also in this category, but lagging in terms of cash flow. All of the integrated majors can adjust to either oil or gas, which ever is more profitable for them to produce.

I'd wait for a commodities pull-back before jumping in, as we seem over-due for one. Be safe out there and do your homework before investing.

Update: 25-Jan-2011: Someone who thinks like me.

Update: 03-Mar-2011: Oil has shot above $100/barrel, breaking out of the wedge (graph above). Gas remains in the $4 to $5 range.

It's the debt, stupid!

2011-01-03T03:51:00.000-08:00

Henry Blodget wrote an excellent economic essay in May, 2009, which is as spot-on today as it was then. It's a long essay, but well worth reading. Although I agree with most of it, I have one major issue with it, which is the abstract way in which debt is measured, as the ratio of debt/gdp (%GDP).

The %GDP ratio is useful when comparing different points in time or different countries, yet it's an abstraction ... a simplified synthetic measurement that has a number of assumptions built into it. In other words, it assumes that all other conditions will remain the same as today. Here are some of the more obvious problems with these status quo scenario:

There is the assumption that modest deficits can continue indefinitely. The budget deficits (n the years between Reagan and Bush43, inclusive) have averaged about 15% of revenue. In other words, the Congress spent 15% more than there was revenue. That percentage has grown to 50% under Obama. Can we get back to 15% with an aging demographic and slow growing economy? Even if we could, can we sustain that level of deficit indefinitely? Blodget is correct in stating that we need to reduce the rate of increase, but doesn't quantify what a sustainable rate of debt growth is, exactly.
There is the assumption that we will continue to pay the same rate of interest on our debt going forward. The historical range of interest rates has been between 1.5% (2010) and and 7.9% (1982), the average being 4.5%. Can we assume that the current rate will continue indefinitely? Blodget doesn't address interest rates at all, which is the most critical error in his analysis.

Let's take these issues one at a time, starting with deficits. Obviously, the rate of deficit has a big impact on whether or not we can actually get out of debt. Blodget seems to minimize this point by using the abstract concept of %GDP. Frankly, I think this is a fallacy of abstraction. When one looks at the national debt in terms of %GDP, it's easy to get into a false sense of security as the numerator (debt) grows more slowly than the economy (GDP). For example, if we realize moderate 5% budget overruns for decades to come, even if under a tepid 3% growth in GDP (the historical average being closer to 6%), then the numerator grows more slowly than the denominator and %GDP magically shrinks over time.

The chart below illustrates this scenario. Note that the level of debt is currently in the 80-100% of GDP range (magenta band in the chart below). If the economy grows at a tepid 3% on average, then the debt (measured as %GDP) will shrink to the 60-80% range, even if we continuously have budget deficits in excess of 10% of revenue. Nothing to worry about, right? The abstraction of debt/gdp ratio makes it seem as if we can continue to overspend forever and the debt levels (measured as %GDP) will actually shrink. It's magic!

If this chart bends your mind a little, it might help to realize that revenues have historically been about 20% of GDP, irrespective of the marginal tax rates. In other words, no matter what the tax rates are, the government has not been able to extract revenue from the economy in excess of 20% of GDP. Therefore, a 10% deficit is 10% of 20% GDP, or 2% GDP. Therefore the increase of debt (2% GDP) is less than the rate of growth (3% of GDP) and thus the numerator is smaller than the denominator, making the debt/gdp ratio shrink over time, even thought the amount of debt is still climbing.

Intuitively, we know that there is no such thing as a free lunch. While (in the above scenario) it seems like we're OK, the amount of debt actually grows from 13 trillion to 26 trillion (in 30 years). Yikes! This brings us to the second issue, which is the rate of interest we pay on the debt. Herein lies the real devil that this trick of abstraction attempts to hide.

As I pointed out previously, the current interest rate paid by the Treasury is a historic low 1.5%, whereas the average since 1966 has been 4.5%. How much would it cost if the interest rate returns to mean (4.5%)? The most meaningful way to express that is in terms of %revenue. Knowing that revenues are always going to be 20% of GDP, how much of that revenue stream will be dedicated to paying interest on the debt?

Currently, revenues are 2.75 trillion and the Treasury paid 197 billion on 13.2 trillion in debt. That works out to 1.5% average interest (197/1320) and 7.1% of revenue (197/2750). What happens if the economy recovers and the Congress continues to overspend and the interest rate increases a mere 1%? At current debt levels, the interest due on the debt increases 132 billion for every 1% increase in interest rate (1% of 13.2 trillion). That 132 billion is 4.8% of the revenue stream (132/2750), which means that if interest rates were to return to "normal" (4.5%) there would be a 14% (3 x 4.8) budget deficit from the increased interest on the debt.. That amounts to a 396 billion dollar hole in the budget! ( [4.5-1.5] x 132 billion). Ouch! The more Congress borrows, the worst this scenario gets.

In conclusion, Blodget's premise (based on this fallacy of abstraction) is that all we need to do is lower the trajectory of debt growth (even if it is still upward). As demonstrated above, we need to reduce the actual debt and not use abstraction to make it seem like the debt is less of a risk than it actually is. The Congress must balance the budget and stop borrowing! The citizens of this country need to be prepared to step away from the public trough, because the credit card is nearly maxed out and the debt is the single greatest danger to our country.

References:

Data from the Federal Reserve (FYFSD, FYOINT, GFDEBTN, GDP).
The spreadsheet I used to calculate these numbers is here.

Profiting from peak oil (part I)

2011-01-02T09:29:00.000-08:00

Investment thesis:

Oil is going to go up in price, due to increased demand and reduced supply.
The dollar remains on a 40 year slide, putting upward price pressure on oil.
Demand will shift to relatively cheaper substitutes, such as natural gas, liquid natural gas and coal.
Demand for drillers will increase to compensate for the lack of oil production.
Demand for mining equipment will increase to compensate for increased demand.
The limited partner structure provides the greatest cash flow and tax benefit.
Dividend reinvestment will lock in high yields indefinitely.
Companies with the highest free cash flow will have the most secure dividends.

In keeping with the above theme, I've sought out basic materials stocks (primarily midstream distributors/processors, drillers, mining equipment manufactures and land royalty trusts) that have low beta, the highest free cash flow (FROIC) and have undervalued price to cash flow ratios (anything with a P/CF of 15 or lower is attractive). The list below contains what I think are the most attractive in this grouping.

Note also that all of these stocks are in the high end of their 52 week price range. There is a tendency for people to shun stocks that have hit their 52 week high, but there is a reason these stocks are at or near their highs ... they're in a sweet spot and firing on all cylinders. (comments continued below).

Name	Symbol	Gain/Loss	Yield	%Range	52wk High	FROIC	P/CF	Beta
Kinder Morgan Energy	KMP	% 15.22	% 6.3	% 90	71.72	% 33	8.1	0.32
TransMontaigne Partners	TLP	32.25	6.6	98	37.00	18	6.9	0.59
DCP Midstream Partners	DPM	26.48	6.7	96	37.85	17	7.3	1.13
Ferrellgas Partners	FGP	21.19	7.7	80	27.28	17	7.8	0.59
TC Pipelines, LP	TCLP	41.14	6.1	97	52.51	17	7.7	0.49
Alliance Holdings GP	AHGP	75.60	4.3	94	49.50	56	11.4	0.75
Natural Resource	NRP	36.96	6.8	99	33.38	37	6.4	0.67
Penn Virginia GP	PVG	57.78	6.1	91	27.37	24	4.5	0.85
Alliance Resource	ARLP	51.63	5.1	99	66.11	22	8.5	0.76
Joy Global Inc.	JOYG	68.21	0.8	97	88.21	38	15.5	2.14
Occidental Petroleum	OXY	20.58	1.6	95	99.57	18	13.1	0.97
W&T Offshore, Inc.	WTI	52.74	1.0	90	20.00	38	3.3	1.50

Return (ex dividend):	41.60%
Total return:	46.53%
Jensen's alpha:	34.73%
Portfolio beta:	0.90
Risk-free (10 yr note):	3.29%
S&P Index	12.77%

Although this portfolio (blue line on graph below) is performing on par with natural gas utilities and coal producers (not shown), notice that many (most) of the the above stocks have low beta, thus the alpha (abnormal return) of the portfolio is 34.7% higher than the risk/reward ratio predicts.

Gold due for a correction?

2010-12-20T10:58:00.000-08:00

Notice the similarities between July-2009 correction (black lines) and where we are today (dotted blue lines). I'd like to see a healthy pullback in gold, but long term, gold has a lot of upward potential. (click on chart for interactive version)

Joy Global Inc.

2010-12-15T09:43:00.000-08:00

Added Joy Global Inc. (JOYG) to the FROIC Alpha portfolio. This is one of the few industrial companies I like, having a large market share in mining equipment, a lucrative servicing income, a backlog of orders and very good free cash-flow. Their quarterly results, just out, reporting a net profit boost by 18% year-over-year. The new numbers reveal that FROIC increased to 38 cents per dollar of capital employed. The price to cash-flow ratio is 15.6, in the acceptable range. Stock was purchased at 85.10/share, up 8% today.

McDonald's Corporation

2010-12-14T09:23:00.000-08:00

Sold McDonald's Corporation at 77.18. The stock broke trend and is losing momentum. Total gain for the stock was 5.45%.

Latest FROIC Candidates

2010-12-09T19:18:00.000-08:00

I've scanned hundreds of stocks for those cash cows that are priced right. The latest list of candidates are here (there are multiple tabs in this spreadsheet).

Colgate-Palmolive

2010-12-09T19:01:00.000-08:00

The chart for Colgate illustrates a huge gap down in in late July due to missed earnings expectations (hyper-inflationary write-downs in Venezuela). Lately, the chart is illustrating a bullish ascending triangle. The stock could break out upward and resume its previous climb.

Colgate generates 48 63 cents free cash (before dividends) for every dollar employed and has a price to cash flow ratio of ~~13.41~~ 10.2. It also pays a dividend of 2.9%. It's priced right and poised to take off.

Update 14-Dec: Major breakout from the rising wedge. This is a buy signal, if the price does not fall back below 79. Wait for pullback and support at 79.

Update 14-Jan: Fell back below the 79 support. Market looking tired. Let's see if the stock pulls out from here.

TC Pipelines, LP

2010-12-09T17:46:00.000-08:00

TC Pipelines, LP (TCLP) has a FROIC of 15% and a price to cash-flow ratio of 8.8 (anything below 15 is very good). It pays a 6.7% dividend to boot. Added to FROIC Alpha portfolio at price-point 47.42.

This is a natural gas pipeline company.

Penn Virginia Resource Partners LP

2010-12-09T17:24:00.000-08:00

Penn Virginia Resource Partners L P (PVR) has a FROIC of 18% and a price to cash-flow ratio of 7.3 (anything below 15 is very good). It pays a 8.3% dividend to boot. Added to FROIC Alpha portfolio at price-point 28.36.

This is a natural resources company that makes more than 80% of its income from resource management and property leasing.

Natural Resource Partners LP

2010-12-09T07:29:00.000-08:00

Natural Resource Partners LP (NRP) has a FROIC of 29% and a price to cash-flow ratio of 7.7 (anything below 15 is very good). It pays a 8.4% dividend to boot. Added to FROIC Alpha portfolio at price-point 31.50.

I particularly like the business model and the fact that it belongs to the raw materials industry. Rather than being reliant on commodities prices, this company receives most of its revenue from land leases and royalties, which keep rolling in whether or not a commodity goes up or down or whether the miner makes a profit or not.

Brown-Forman Corporation

2010-12-07T04:02:00.000-08:00

Brown-Forman Corporation (BF.B) has had a parabolic ramp-up and it's time to take some profit. Futures for the market are up this morning, so let's see how far BF.B will climb before the inevitable correction. Placing a stop at $68.00.

Update 7-Dec 11:16. Downgraded by Deutsche Bank. Sold at market: 69.63

Sun Logistics Partners LP

2010-12-06T21:08:00.000-08:00

Added Sun Logistics (SXL) to the FROIC Alpha Portfolio. Price to cash flow is 7.5, which is very cheap. FROIC is 17% (a little below my usual 20% minimum requirement) but it pays out a 6.1% dividend and has a very low beta of 0.12. On a risk-adjusted basis, it is far outperform the S&P500. Purchase price: 81.79.

Altria Group Inc.

2010-12-04T07:59:00.000-08:00

I've been sorting through a lot of data to find the best FROIC candidates for the FROIC Alpha portfolio. Up to now, I've been using a Darwinian approach of finding FROIC stocks that outperform on severe dips of the S&P500. I've found some beauties that way, but the stock market is not dipping lately, so I've begun the long and arduous job of filtering through thousands of stocks to find undervalued stocks with the best cash flow numbers.

I'm currently sorting through the Consumer Goods sector, and I ran across Altria Group Inc. (MO). The dividend and cash flow numbers look good. Technically, it's approaching an over-sold condition. Wait for the Bollinger bands to narrow and for a breakout through the upper band. That would be a buy signal.

I'll eventually publish my search/sort/scan results for all the major sectors, but I wanted to give everyone a heads-up on this particular stock. It's not often you run into an under-valued stock that generates 69 cents of cash for every dollar put to work, outperforms the S&P and pays out a 6% dividend too.

Reynolds America Inc.

2010-12-02T07:04:00.000-08:00

Reynolds is in my FROIC portfolio. They announced a 2:1 split on Nov 16,2010. Nice!

The sinking dollar

2010-12-02T02:17:00.000-08:00

The purchasing power of the U.S. dollar has been declining for many years, when compared to a basket of major currencies (Euro Area, Canada, Japan, United Kingdom, Switzerland, Australia, and Sweden). There are reversals from time to time, but the overall trend is undeniably downward. It shows that the U.S. is winning the race to the bottom to competitively devalue the currency faster than other major currencies.

On a technical note, the dollar is in a gigantic falling wedge. The overall downward trend will not be broken until the dollar breaks out of the upper bound.

The dollar story is a little different when compared to emerging market currencies (Mexico, China, Taiwan, Korea, Singapore, Hong Kong, Malaysia, Brazil, Thailand, Philippines, Indonesia, India, Israel, Saudi Arabia, Russia, Argentina, Venezuela, Chile and Colombia). Nevertheless, the dollar is beginning to win the race to the bottom against these currencies also. There was a flight to the dollar during the "great recession", but the trend is down for the dollar.

Sources:

Trade Weighted Exchange Indexs, FRED, The Federal Reserve, St. Louis.
How Long Will the U.S. Dollar Be a Safe Haven?, John M. Manson, Seeking Alpha

Is gold a bubble yet?

2010-12-01T14:12:00.000-08:00

I wanted to come up with a way to measure the purchasing power of a global commodity, such as gold or oil, priced in dollars. It occurred to me that there are three factors influencing the price of gold:

Money printing, as documented by the CPI. The dollar is now worth 20% of what it was worth 40 years ago. Inflation is purely a function of too many dollars chasing too few goods, and it's astounding how much the Federal Reserve has taxed us via inflation.
Exchange rate, as documented by the dollar index (using a basket of major currencies). Nearly all countries devalue their currency over time (money printing) but they don't all do it at the same rate (some far less than others). If all currencies devalued at the exact same rate (pegged to the dollar) then we'd only need to adjust for CPI and could ignore the dollar index. Although there are periods of relative strength for the dollar (flight to safety) the overall trend is unmistakably down. The dollar has lost 40% of its purchasing power in the last 40 years, relative to a basket of major currencies.
Normal supply and demand. There is a finite supply of gold and it is difficult to produce. Thus, the price of gold has more to do with buying/selling than it does consumption/production.

To illustrate the historic purchasing power of gold, in terms of dollars, is it appropriate to adjust both for CPI and the dollar index. You can think of this as a kind of "Big Mac Index" to compensate for relative purchasing power. Instead of using a Big Mac, however, I'm using another global commodity, gold. I first got this idea from Kitco's Gold Index, where the daily price movement of gold is measured both in terms of buying/selling and change in dollar index. For example, gold might drop 4 dollars due to selling, but gain 7 dollars due to the weakened dollar, for a net gain of 3 dollars.

The interesting twist is that the index is always in reference to the current year. In other words, the more the dollar devalues, both in terms of exchange rate and inflation, the more the left-hand side of the graph rises as measured in today's dollar (see graph below), thus the more distance gold can travel upward on the right-hand side of the graph before hitting its 1980 peak. There is plenty of room for gold to climb, more so if the dollar continues its long term decline.

Note that the chart below reflects average gold price for a given year, therefore the peaks don't necessarily coincide with an annual peak or an all-time peak. I'm more interest in the overall trend while smoothing out the volatility.

Sources:

Trade Weighted Exchange Index, FRED, The Federal Reserve, St. Louis.
Consumer Price Index, ibid.
Spreadsheet, derived from FRED.

IAC/InterActive Corp.

2010-11-30T05:47:00.000-08:00

Adding IAC/InterActive Corp.(IACI) to the FROIC portfolio. This is an internet company that has good cash flow and technical performance. I wouldn't normally look to this type of company, but I think it's ripe as an acquisition target. Note that this was #1 on my latest FROIC candidates lists. Bought at 28.39/share. Stop loss set at 26.50.

FROIC Candidates

2010-11-23T04:44:00.000-08:00

I have a new list of FROIC candidates. I did something a little different this time around. I scanned for stocks that had a low beta and were outperforming the S&P. I used FROIC to narrow the list to 11 candidates, several of which were uncovered in previous scans back in June and August. The new list of candidates is here.

Had I owned these stocks a year ago, here is how they would have performed relative to the S&P500 (excluding dividends).

AT&T, Inc.

2010-11-22T19:42:00.000-08:00

AT&T (T) is showing technical weakness. Setting stop loss at 27.50.

YUM Brands

2010-11-22T19:29:00.000-08:00

Yum Brands (YUM) is showing signs of a weakness. FROIC decreased from 29% to 25% while price/cash flow increased from 14.5 to 16.5. Placing a stop loss at 48.

The incredible shrinking dollar

2010-11-22T16:49:00.000-08:00

Courtesy David Dees illustration Studio

Gold is a better measure of value than the dollar. It's quite common to say that gold went up or down x dollars; which is not an accurate way to describe what happened. In truth, gold often retains its value and it is the dollar that has gone up or down relative to gold.

Look at the chart below. The blue line is the purchasing power of gold as measured in a basket of 10 major currencies. The red line is the purchasing power of gold measured in dollars. Notice that the gold index (blue) has essentially retained its purchasing power while the dollar (red) has been declining in purchasing power, requiring more and more dollars to buy the same amount of gold. This is clear evidence of the incredible shrinking dollar ... going, going, puff! Gone.

The Kitco Gold Index is explained here.

Update on Richard Koo

2010-11-19T12:07:00.001-08:00

Richard Koo, Chief Economist,
Nomura Research Institute

A year ago, I drew attention to Richard Koo's book and scholarly work on what he calls a "balance sheet recession". Since then, he's gotten a lot of recognition. Here is the latest from Business Insider with a presentation from Koo, illustrating why quantitative easing (money printing) is doomed to fail (although he doesn't realize that's the point he's making).

In essence, a balance sheet recession occurs when businesses and consumers shun debt at any interest rate. It's the "paradox of thrift" or "fallacy of composition" in which each individual is doing exactly the right thing - on a micro-economic basis - but are wreaking havoc at the macro-economic level because everyone is repairing their balance sheets at the same time (save more, pay down debt). This decreases aggregate demand for goods and services, which causes the economy to contract. When the private sector pays off debt, the high-powered money leaves the economy, and the money supply shrinks.

Nobody seemed to care that the previous 30 years of growth was due to excessive credit, but now suddenly everyone cares that we avoid the de-leveraging of that credit. It can't be avoided. A correction is required.

The government attempts to forestall the correction by:

Making up the difference in aggregate demand through government borrowing ... and
Making up the decline in high powered money by attempting to pump more into the economy.

The paradox under this interventionist policy is that the more that people save, the more the government borrows and spends to counteract the decline in aggregate demand. The more that the private sector tries to pay down debt, the more the government prints money to try to counteract the decline of high powered money. The end result is a transfer of debt from private hands to public hands. The debt doesn't go away and the savings are invested in government bonds instead of productive ventures in the economy. Such is the fallacy of Keynesian thinking. Richard Koo simply gives a new name to an old idea, the liquidity trap.

Here are fallacies that Koo and Krugman do not address:

Money is an exchange medium between labor and production. Therefore, the government can not create money from thin air as it ultimately must draw down from the productive parts of the economy to support its activities. It's a zero sum game (at best) as government spending does not "add" to the economy. We cannot all "stimulate" one another with money and come out ahead.
Koo and Krugman distrust capitalism and think government intervention can correct its flaws. They fail to accept the idea that default is a healthy part of a risk/reward equation of the capitalist system. Creative destruction begins when unproductive pursuits are allowed to fail. This process is thwarted when risk-takers are allowed to socialize their losses and privatize their gains.
The economy will return to self-sustaining growth when the private sector repairs its balance sheet. However, this process is delayed (indefinitely) by government intervention (20 years of economic funk in Japan).
When the government tries to mitigate all risk of loss, by taking the risk upon itself instead, there is the danger of a currency crisis, which is far worse than if the private sector had been allowed to reset on its own.

What then should the government do? Dismantle the regulations that hamper the economy, reduce spending and reduce taxation. Get out of the way and let capitalism work. The process of reallocating resources is painful and messy, but can not be avoided. The outcome is much worse with government interference. Adopting Krugman's and Koo's proposals will result in an endless economic funk, at best, but a currency crisis at worse.

The ruling class does not want to give up governmental control of the economy while the oligarchs do not want to realize the losses from their bad bets. That is the essence of why we are stuck here.

Urstadt Biddle Properties

2010-11-17T10:11:00.000-08:00

FROIC Update: Urstadt Biddle Properties (UBA) shows a bloated P/E, has increased its debt, and has a declining yield. FROIC has dropped 1.6%. Recent price weakness is not an immediate concern so long as it stays above the lower trend line. Placing a trailing stop-loss at 2.5% below lower trend line, currently at price point 18.25.

Scotts Miracle-Grow

2010-11-17T09:20:00.000-08:00

FROIC portfolio update. Scotts (SMG) has increased their dividend (from 12.5 to 25 cents), bought back stock and reduced their debt. Forward PE was getting a little high, but the stock has recently corrected, bouncing off of its lower trend line. The fundamentals give me enough confidence to doubling up on this stock for a short-term gain. Adding 19.84 shares at 50.40/share to the hypothetical portfolio of $25K.

The decline of an empire

2010-11-11T14:04:00.000-08:00

Put in simple terms, when more money leaves the country than enters, it creates a current account deficit. (This deficit should not be confused with budget deficit). Under normal circumstances, when a deficit grows, it tends to have a downward pressure on the dollar, which tends to favor exports, which helps alleviate the deficit. The reverse is true for a surplus. Interest rates also affect the demand for the currency and can attract or repel investment from the country. In the end, things balance out.

There is another factor that can affect net account balances, besides trade and interest rates. The U.S. employs 1.5 million military personnel in over 700 military bases around the world, which amounts to hundreds of billions of dollars exiting the country each year to maintain our vast empire. This has a negative impact on the current account. Add to this situation, the decline in domestic manufacturing (reduced exports), zero interest rates (discourages savings and investment), and the rampant money printing to finance the budget deficit.

Why should we care about the current account deficit? Large, sustained account deficits drain capital investment, increase borrowing and place a drag on the economy. As you can imaging, this is not sustainable as our creditors eventually lose faith in the sinking dollar, which then becomes a pariah currency. Borrowing costs can increase rapidly as lenders and investors flee the dollar. The value of the dollar can decline rapidly, making imports very expensive (food and energy). It means economic decline and along with it an inability to maintain our military presence around the globe.

Ron Paul has been warning for a long time that the cause of our current account deficit had less to do with China's supposed currency manipulation, and a lot to do with financing our global empire (with a credit card, no less). He has been a lone voice in the wilderness on this issue. Now, it's becoming common knowledge as others add their voice to Dr. Paul's. The dollar is soon to go kaput and the vast military empire is destined to shrink. I take no joy in pointing this out, but I think it's time that Americans realize what the rest of the world already knows.

Why the CPI is bull 5h1t

2010-11-10T10:20:00.000-08:00

Click to enlarge.

Amended and redacted:

I was quick to judge Sarah Palin, but I recently read her Facebook Page, and I have to say she's spot on. Kudos, Sarah.

There is a back-and-forth between the WSJ and Sarah Palin about money printing and inflation. She said:

"We don’t want temporary, artificial economic growth bought at the expense of permanently higher inflation which will erode the value of our incomes and our savings".

At first glance, she seems to believe the same false economic assumption that Obama is under, that printing money causes economic growth. It doesn't, and her subsequent writings make it clear that she understands this concept. She is raising the issue of the Fed's ill-advised attempts to monetize the debt. Kudos, again.

Obviously, she can't blame the Fed's latest round of money printing for the food price inflation that has occurred over the last year. The previous round of money printing is the cause, which she supported - i.e. the $700 billion Emergency Economic Stabilization Act of 2008 ( and something her TEA Party supporters never forgave the GOP for). Based on the comments from her FB fans and supporters, I don't think they make the connection.

Ah yes, but does the WSJ set her straight in their reply?

Unlike most U.S. economists and politicians, however, Palin tries to draw the concerns about quantitative easing to inflation today and falls short. [...] Grocery prices haven’t risen all that significantly, in fact. The consumer price index’s measure of food and beverages for the first nine months of this year showed average annual inflation of less than 0.6%, the slowest pace on record. [...] That’s not strong evidence to argue about rising prices today.

Producer prices are above their pre-inflation levels and growing at a faster rate than consumer prices. It appears that the WSJ is correct, but how then can Palin account for the pain at the grocery store?

In truth, the CPI is a highly doctored number that understates inflation very significantly and does not take into account the hit to personal income. In the early eighties, the BLS switched to hedonics and geometric weighting to artificially manipulate the CPI downward. This has resulted in at least a 0.7% understatement per year, compounded for 30 years. In essence, we've all been secretly taxed (through inflation) at a much higher rate than we were led to believe. Furthermore, seniors have been receiving far less than what they should under Social Security. Shrinking incomes, high unemployment, slow growth, higher inflation ... it's called stagflation. That's what we've been feeling in our wallets.

In the final analysis, Palin is right (as much as it pains me to admit) and the WSJ is simply parroting other talking heads and doing little original as journalists (which is why I canceled my subscription).

It would be great if Sarah talked about the fraudulent CPI and how this is ripping off everyone, especially seniors. Maybe I can get a message to her. :)

Go Sarah!

Which currency is best?

2010-11-04T21:37:00.000-07:00

The Australian Dollar / Gold ratio:

The U.S. Dollar / Gold ratio:

Why does the Australian Dollar, New Zealand Dollar, and the South African Rand all follow gold more closely than the dollar? Because these countries have growing, commodities-based economies and their governments aren't running the printing presses non-stop in the race to the bottom. Just plug in your currency of choice into this chart and see how well it tracks commodities.

Of course, you could just buy DBC and DBA together, instead of specific currencies. Whatever you do, get out of the dollar.

Transitioning out of the dollar

2010-11-04T20:54:00.000-07:00

Austerity is on it's way with the GOP back in the saddle (or at least one foot in the stirrup) . If they deliver on the mandate from the electorate, there will be budget cuts. Most economists think this will be bad for the economy. I think it doesn't really matter because we're broke and can't continue this way without creating bigger problems not-so-far down the road.

With fiscal policy constrained, the only tool left is monetary policy ... and so Helicopter Ben has put the printing presses on overtime. Ben knows that the only way out of this hole is to monetize the debt. Nearly every commodity climbed dramatically today as a consequence. Gold up more than $50 in a single day. Equities broke through overhead resistance and are on their way up, up, up (perhaps after a correction, first).

If you're savings are in dollars or dollar denominated bonds, you're going to lose your shirt. Commodities, foreign currencies and emerging market equities are going to help save the purchasing power of your savings. U.S. Equities will also inflate, but probably won't do as well because of the weak economy and constant dollar devaluation.

FROIC 11/4

2010-11-04T20:23:00.000-07:00

I posted an update to the FROIC Alpha Portfolio, here.

Ready for the sell off?

2010-10-29T22:06:00.000-07:00

What a crazy, irrational market. On October 4, I made the case that things were getting toppy (using Fibonacci Retracement). Three weeks later, and no market correction. I'm usually a week or two early on these prognostications anyway, but this ridiculous.

Below is one of my favorite charts that compares stocks above their 50 DMA as a ratio to stocks above their 200 DMA. As stocks begin to drop below their 50 DMA (in aggregate) a parabolic top forms on the chart, and the MACD shows a loss of momentum while stocks keep climbing. This set-up is only reliable if the Bollinger Band Width Indicator shows that there is a choke point in the bands (vertical red lines). You can find working examples of these charts on the chart page. Click on this image to enlarge it.

Next is is a comparison of the the 3-month implied volatility futures ($VWV) as a ratio to the current month implied volatility ($VIX). Whenever the ratio jumps to 1.25 (red circles), the MACD is losing momentum, and the Bolliger Bands are beginning to widen, it's a signal that the volatility will increase (market sell off). Click on this image to enlarge it.

The method I use to short the market is a buy stop on a reverse ETF. This gives me the luxury of riding the up-trend as far as an irrational market will take me, confident that the eventual sell-off will be sharp and precipitous. Again, the key is the Bollinger Band width as it indicates a choke point (red circles). I set the buy stop at a point midway between the 1 and two 2 standard deviations (blue and red bands). If the buy stop kicks in, I set a stop loss at about 3.5% below the buy price, but the stop is upped to "break-even" when the trend is established. I sell any time that the price shoots way above the 2 standard deviation band line (but I try not to get greedy).

Notice that we're at another choke point again as the market is poised to correct. The buy stop gets adjusted downward each day that the bands drop further. Click on the image to enlarge it.

What "Change" means

2010-10-24T21:45:00.000-07:00

Click to enlarge

In a single word, lies! The White House has put out a moronic video aimed at deceiving the electorate about jobs and the stimulus.

The centerpiece of the "Change" unemployment propaganda is the chart to the right. The intent is to give the viewer the impression that job losses immediate turned around after Obama took office. The reality here is that this is a rate-of-change chart, meaning that when the chart is at zero, we are at the nadir (bottom) of the unemployment losses and have yet to climb out of the huge hole. This is a common deception used by DNC talking heads. In fact, a large portion of the jobs being created were temporary census jobs and job creation has essentially been flat for the last 9 months.

Below are the charts that illustrate the proper way to look at unemployment.You can click on any of these to go to the St. Louis Federal Reserve research site.

Percentage of the workforce employed:

Total unemployed:

Average duration of unemployment:

Foodstamps Vs. Paychecks

2010-10-09T22:39:00.000-07:00

Today, Speaker Pelosi seemed offended by Newt Gingrich's suggestion that the food stamp is the right symbol for the Democratic Party. She also claims that every dollar spent on food stamps, puts $1.79 into the economy. Does anyone see a problem with that math?

Although it's plausible that the multiplier effect and the velocity of money will turn a buck into 1.79, one can not remove from the equation the fact that the buck was taken from one person and given to another. If I take a buck from you and spend it, it doesn't stimulate the economy any more than if you had spent the buck yourself. Speaker Pelosi neglects to subtract the dollar from the equation. It's as if she thinks the government already owns your paycheck and knows best how to spend it.

Feeding the poor during hard times is something most Americans are sympathetic to, but let's stop pretending that welfare checks and food stamps are anything more than transfers of wealth. There is no new wealth created in that transfer. Wealth is created in productive enterprise, which is what makes the economy grow. Speaker Pelosi should know that paychecks are vastly better at stimulating the economy than food stamps are. If you want to understand how to create jobs, just talk to a small businessman (here and here).

Bond bubble?

2010-10-06T11:57:00.000-07:00

Paul Krugman

The chorus is singing: "It's a bond bubble, can't you tell? It spells trouble; time to sell !" The WSJ and even Warren Buffet are telling investors to sell bonds and buy stocks. Nobody's listening, not even the premier bond trader, Bill Gross. As much as Paul Krugman annoys me, I think he has the right answer. Bond yields can stay low for many years as we face slow growth and recessionary pressures.

As you can see from the chart below, bond yields and stock prices are diverging again. Which one is correct? I'm betting that bonds are correct. I'm currently short the SPX.

Links

2010-10-05T12:23:00.000-07:00

Added Weekly Insider Sales and Sentiment Survey to the links page.

Toppy? Fibonacci Analysis:

2010-10-04T10:50:00.000-07:00

The markets are looking "toppy" again and ready for another leg down. In addition to my usual analysis, I'm adding some additional color with a Fibonacci analysis.

Do I think Fibonacci is reliable? Not by itself. Perhaps in combination with other momentum indicators, it may be helpful. Of course there are those who adhere to Fibonacci analysis like a religion, and that - in itself - is reason enough for me to look into it. What I mean is that if a lot of people follow something - like the 50 DMA or the 200 DMA etc - then it becomes significant. It becomes real because people believe it's real. The markets respond, because markets are made of people (at least I hope the machines haven't completely taken over yet).

As you can see from the Google search trends (below) there has been a renewed interest in "Fibonacci Retracement" since the 2008 crash. Notice how the news reference volume surged as well, which means it's getting broader attention. I was surprised to find prominent analysts using Fibonacci analysis also. (Click on the image below for more details.)

So then, let's apply some Fibonacci analysis to recent market action. As you can see from the chart below, the recent Jan-2010 and Apr-2010 tops are 50% and 62% retracements of the plunge that began in Oct-2007 (blue lines). Also note that the severe drop from the Apr-2010 high has bottomed out at 62% of peak gains since the Mar-2009 low (red lines). The last point of interest is that the market is looking "toppy" lately, just as the market regained 62% of the losses since the Apr-2010 high (green lines).(Click on the image below to enlarge.)

Does it look like voodoo to you? It does to me, but we can count on a lot of people believing this voodoo and acting accordingly. Below is my usual technical analysis using momentum indicators and the sentiment of the smart money. The chart below tells me we are near a local top and will have a correction, probably starting tomorrow. Where's the next bottom? Perhaps S&P 1040, 1020 or 950. Get your stop losses in place and shorts, if you're conviction is strong. :) (Click on the image below to enlarge.)

References:

Fibonacci Retracement, Chart School, Stockcharts.com
Google Trends for terms "Fibonacci Retracement"
David Rosenberg, Fib retracement below 950, Bloomberg
A Bullish Fibonacci Call, Seeking Alpha
Other Fibonacci Articles on Seeking Alpha
The Dow Theory, Chart School, Stockcharts.com

Good entry point

2010-08-26T21:25:00.000-07:00

One of the challenges in stock purchasing, especially in this market, is finding a good entry point. I've found that a combination of Bollinger Bands and the standard 50/200 moving average helps greatly (RSI and MACD are also helpful). Assuming that the 50 day is above the 200 day, and that the stock is also above the 200 day ... look for price to drop below the Bollinger Band (note July-1 below). That's about as good as it gets. Keep a stop-loss in place to ensure that you don't loose money if you get the entry wrong.

FROIC Alpha

2010-08-26T20:49:00.000-07:00

I first wrote about FROIC here and created an equal-weighted equity portfolio in July. FROIC is (Free cash-flow Return On Investment Capital). It's a measure of how much free cash a company can generate for every dollar employed. I've found it such a useful tool, that I've dedicated a new page to track my budding FROIC-based portfolio (below).

Today is 26-Aug-2010. Below is the most current portfolio, created 01-Jul-2010. Notice that the portfolio beta is less than 1.0, which means that it is below average risk. Also notice that Jensen's Alpha is 9%, which means that this portfolio is outperforming the S&P 500 by 9% (on a risk weighted basis).

My original stock list has dwindled. Several stocks sold off within two weeks of purchase (break-even stop-loss orders). Stocks that were dropped are Netflix(NFLX), NutriSystem Inc (NTRI), Diamond Management (DTPI), Hasbro Inc. (HAS), The Hershey Company (HSY) and AmerisourceBergen (ABC). This is part of the Darwinian process such that only the best survive. The next list of candidates is here.

Name	Symbol	Beta	Return
Compania Cervecerias Unidas S.A. (ADR)	CCU	0.78	31.77%
Herbalife Ltd.	HLF	1.70	15.38%
The Scotts Miracle-Gro Company	SMG	0.69	8.30%
Coca-Cola Enterprises Inc.	CCE	1.34	9.30%
Campbell Soup Company	CPB	0.34	3.21%
Continental Airlines, Inc.	CAL	1.18	4.13%
Urstadt Biddle Properties Inc.	UBA	0.66	8.28%
Penn Virginia GP Holdings, L.P.	PVG	0.80	5.59%
Alliance Resource Partners, L.P.	ARLP	0.77	20.85%
TransMontaigne Partners L.P.	TLP	0.68	15.97%
StoneMor Partners L.P.	STON	0.92	18.06%
Plains All American Pipeline, L.P.	PAA	0.39	4.75%
Yum! Brands, Inc.	YUM	1.04	9.40%
Average		0.87	11.92%
Jepsen's Alpha			9.06%

Risk Free (10-Yr Note)			2.50%
S&P 500 Index		1.00	2.92%

Bearish technicals

2010-08-15T09:00:00.000-07:00

The S&P500 technicals are looking very ugly. It's clear that we are beyond a "correction" as previously anticipated, and into something more ugly than that. Other than the much talked about "head-and-shoulders" pattern, we have a broken trend, double top, bearish rising wedge, and a double bottom breakout. Next support at 1010. I'm currently short the S&P and (dare I say it) long on gold, despite being a gold pessimist in the past. Little did I know then that we'd see sovereign debt crisis emerge.

Click on the chart to enlarge it.

Three scenarios for gold

2010-08-10T14:26:00.000-07:00

Today, the 10yr note dropped simultaneously with the dollar, as gold spiked. It all happened at 2:15 today, when the Fed announced that it will begin quantitative easing again (to halt deflation). The relationship is unmistakable.

There are three scenarios, that I can foresee, that will affect gold in different ways:

The Fed prints more money (quantitative easing). The economy will recover very slowly while the national debt continues to skyrocket. Gold will increase in value to match inflation and the declining dollar.
The economy will not respond to stimulus, and confidence in the dollar will be lost. Gold will increase in value as a safe haven against the collapsing dollar.
The Congress will get its act together and come up with a plan to balance the budget, shrink the debt and stop interfering in the economy. The market and economy will recover, unemployment will drop, gold will drop in price as the dollar recovers and confidence is restored.

The odds of #3 happening soon are slim-to-none, and so I think gold will retain its value or appreciate in value for the foreseeable future.

Next leg down?

2010-08-10T13:51:00.000-07:00

The market is looking like it's near it's short-term top:

Money flow and volume are declining on rallies (see chart below).
There is a divergence of stock and bonds, suggesting that stocks are over bought.
The market is approaching a parabolic top, similar to the April/May sell-off.
There is a 20% difference between the current volatility and the predicted volatility.
The economy is faltering and is dependent on the Fed to "prop it up".
The dollar and treasury bond yields dropped like a rock today, as gold spiked.

The story of Volume

2010-08-03T14:28:00.000-07:00

There has been a lot of hoopla lately about a rising market on decreased volume, and volume spiking on sell-offs. Are we at a medium-term top? I decided to compare the top of 2007 to the recent market trend. The results are below (click to enlarge):

2004-2007	2007-2010

Today's market

2010-07-22T07:05:00.000-07:00

Good news for the market, apparent (a 200+ point jump this morning), because there were larger than expected initial jobless claims and the Fed Chairman is saying that the economic outlook is "unusually uncertain". None of the talking heads have a clue why the market goes up or down. Sell the rally if you're long.

New charts

2010-07-21T15:08:00.001-07:00

I've added a few new and interesting charts to my charts page.

Contrarian VIX signal

2010-07-21T05:05:00.000-07:00

Hat tip to "Gold vs. Paper" for an innovative contrarian chart comparing the ratio of 3-month VXV futures to current VIX. The phenomena under observation is when the ratio trends higher (because the current volatility is lower than the anticipated volatility). This suggests a higher degree of complacency from current stock/option investors compared to supposedly more sophisticated futures investors.

I've added an Aroon Oscillator to help make the signal easier to detect. I'm also using the Elder Impulse System for the first time. Note that no detector is perfect, as you can see a lack of signal highlighted on the chart.

Today's market action

2010-07-20T14:54:00.000-07:00

Lately, there has been a correlation of nearly every asset, except precious metals. For example, if you compare the 10 year bond yield with equities, you see a correlation. Today, there was a huge divergence of the two. I think I know why.

Using TRIN to signal market turns

2010-07-19T12:47:00.000-07:00

The NYSE Short-Term Trading Arms Index - or TRIN - is typically used to identify over-bought or over-sold conditions in the market. It's useful for short-term trading signals, but assumed not to be of much use for long-term signals because of the volatility of the index.

I decided to apply the Average True Range (ATR) indicator to the weekly TRIN index to assess the volatility trend over time. The volatility of the weekly TRIN does appear to increase prior to market turns and it peaks at the market bottom.

By picking arbitrary thresholds for the ATR, I plot each threshold breach onto the S&P chart for the last two bubbles (as you can see below). You can view the detail for the top of the dot com bubble and again for the top of the housing bubble. The recent TRIN volatility has spiked at or around the Dubai/Greece crisis and again very recently due to the EU debt crisis (or fears of a double dip, perhaps). It's not looking very good for the bulls.

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Baltic Dry Index

2010-07-17T02:57:00.000-07:00

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The Baltic Dry Index measures freight rates for international shipping. Bloomberg News noted Friday that the index had finally broken the longest continuous drop in fifteen years, on speculation that owners are refusing to offer vessels at current hire rates.

Prices for dry bulk shipping, which doesn't include energy commodities, tend to be very sensitive to economic activity. A sharp drop in rates indicates a significant drop in global trade. Lack of shipping activity from China, the engine for global economic activity, was cited as the main cause for the falling index.

The index seems to be most closely correlated with prices of industrial commodities and the industrial sector of the global economy. While this is not the largest component of the U.S. economy, it is the key sector in developing economies.

The graph below overlays the BDI (which is shown as a blue zig-zag) with the S&P500 and includes a Relative Strength indicator. Note that the RSI is at the same level it was in Sep-2008, just before the market meltdown. Also notice the similar wedge with head-and-shoulders breakdown patterns of the BDI. This chart was added to the charts page.

Barring any financial shock/panic, I think we'll see a short-term bottom at about DOW 9650 and S&P 1000. There will be one last surge after that, taking the indexes back up near the April highs, then back down again to 9600/1000 just in time for the 2010 elections. After that, we're probably looking at chop city all the way to DOW 6000 by 2012.

Gold Stocks Vs. Gold ETF

2010-07-01T13:32:00.000-07:00

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I received some unsolicited advice to invest in gold mining companies instead of a gold ETF. The well-meaning gentleman gave me some propaganda to read. Being skeptical by nature, I did my own analysis. I came across this quote from the propaganda that didn't pass the "smell test":

Investors know they need some Gold in their portfolio, and most know that gold stocks outperform the metal by a 3 to 1 ratio over time. This is because every $1 increase in gold price goes straight to profits, and all a company's ounces still in the ground become more valuable.

This just didn't ring entirely true to me because of simple common sense. The gold minders have to spend a lot of money to get each ounce out of the ground and process it etc, so the value of the mining company does not go up equal to the increase in the value of gold.

It would make sense that if you want to find an attractive gold minder, you'd look for one that has decent free cash flow which it can use to extract more gold. In reality, the vast majority of the gold miners are a nightmare in terms of free cash flow and most have very large debts. I decided to do a FROIC analysis on gold minders, but then remembered that someone else has already done one. Here are a few quotes from that article:

I went and analyzed a group of Gold Stocks and found some very disturbing results from a free cash flow point of view, a real horror story.

The gold industry has by far the worst results as a group of any of the 600 Industries that I track.

GLD was a rock during the last market crash while the stocks themselves went down along with the market. Thus, the results clearly show that GLD is the stronger candidate to have if you expect a market downturn.

So in conclusion, my findings show that in down markets there is no advantage to owning Gold Stocks vs. the commodity, but if you believe that the markets will be strong for the next few years, then those with strong free cash flow numbers may outperform. It all depends on your viewpoint of where you think the market is heading.

It's important to note that there were only three gold minders out of 34 candidates that show a positive free cash flow. Of these three, the stock prices did not perform as well as gold ETFs themselves. If you lust for gold, purchase the real stuff or a commodity ETF. You'll be better off (in my opinion).

Darwinian Stock Picking: FROIC

2010-06-30T22:24:00.000-07:00

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After each market correction, I scan for the best performing stocks and evaluate them for FROIC (Free cash-flow Return On Investment Capital).

The first step in this process involves Yahoo's stock screener (the Java version) to take advantage of Darwinian selection to find stocks that are at least 1% above their 200 day moving average (after a market correction). I add a few additional criteria to limit the selection to mid-cap or larger. You can add any other criteria that suits your fancy, but try not to get too selective in the first cut (the main objective is to measure FROIC and a price to free cash flow ratio). The exact criteria I used for my recent screening is displayed in the box, below right. Once you have your initial cut of the heard, export the data to a spreadsheet to calculate FROIC and the price per free cash flow ratio (explained below).

Filter Criteria

Market Cap >= 2b
Book Value >=1
Shares Outstanding >=10m
Total Debt >=0
Free Cash Flow >=0
200 Day Moving Avg >=1

FROIC tells the investor how much free cash flow is generated for every $1 of capital that a company employs. A healthy business needs a healthy cash flow to grow without relying heavily on leverage. For example, NutraSystem generates 50 cents of free cash flow for every $1 of capital employed. A detailed example of how to calculate FROIC can be found here. I look for stocks with a FROIC of about 35% or better.

In the case of NutraSystem, 50% cash generated per dollar employed sounds impressive ... but is the stock over priced? Maybe the best opportunity to buy has come and gone. The way to judge is to divide the current share price by the free cash flow per share. For example: Today's closing price for NutraSystem was 23.44 and the company currently generates 2.15 of free cash flow per share, thus the price to free cash flow is 23.44/2.15 = 10.9. Anything below 15 is very good, although I sometimes consider a higher ratio if the FROIC is very high (such as NetFlix or Hershey).

The next step is a simple sort of the spreadsheet by FROIC and then again by the price to free cash flow ratio. You want stocks to bubble to the top that have the highest FROIC and the lowest price to free cash flow ratio. This is your second cut of the heard. You can download the result of this screening here.

Next, I like to look at the stock chart of each candidate stock to visually check recent performance. You'll know an ugly chart when you see one. As you can see from the chart below, NutraSystem is holding up pretty well given the beating the stock market has taken lately. I check off all the stocks that have decent looking charts. This is the third cut of the heard. (Continue reading after the chart below).

Finaly, you need to do your homework and read the 10K/10Q for each candidate stock. Understand what you're getting into. Are there any major lawsuits? Is the company headquartered in a banana republic? How healthy is the economy in that country? Is this a sector that performs well in the current business cycle? Is there enough liquidity to be able to sell this stock later? Is the return commensurate to the level of risk? Are there tax implications? What does the PEG ratio and forward P/E look like? What do research analysts say about this stock? Does this stock add the desired diversity to your portfolio? You get the idea. Always assume that you're going to keep this stock for a long time, because that's the whole point of calculating FROIC.

Now of course, if your convinced the whole market is going down the crapper, there's no point in buying any equities at all ... but dips are certainly the best time to buy.

Allan Meltzer

2010-06-30T09:09:00.000-07:00

Added Allan Meltzer to my "spot on" list for for his commentary in the Wall Street Journal in which he lists nearly every reason Why Obamanomics Has Failed. Mr. Meltzer is a professor of economics at Carnegie Mellon University, a visiting scholar at the American Enterprise Institute, and the author of "A History of the Federal Reserve".

The math is wrong

2010-06-30T04:40:00.001-07:00

This post is a follow up to How to Postpone a Depression: Pull Future GDP Forward. I read a brief note from Nassim Taleb yesterday that got me thinking about this post. Here is what Nassim said:

I just realized that what is called "Keynesian stimulus" works differently when the government is starting off a situation of deficit. The math would produce different results, which makes me wonder why economists cannot spot it (I inject more perturbations and see massive fragility). In one case, to make an analogy to an individual, you can invest money you have on the side(assuming you've had surpluses [sic] from the past). In the other, you fragilize yourself by borrowing, and transfer the liabilities cross-generations. Patris delictum nocere nunquam debet filio. [A father should not leave liabilities to his son.]

But you can't expect economists to perturbate their models, or inject rigor in their arguments. They are the very same idiots after all who got us here.

Nassim's thoughts prompted me to re-evaluate my previous post. If anything, I think that my previous post was spot on. If you are "stimulating" the economy using a rainy day fund or excess reserves etc. then you are essentially spending a portion of GDP that was stored up. If, however, you had no reserves or no rainy-day fund to draw on, then you are merely drawing from future GDP, which is like living on a credit card. It's not sustainable and you're rolling the dice whether or not you can repay the deficit in the future.

Given the unprecedented trillions of debt we (and much of the developed world) have racked up, I think the odds are against a happy outcome. Perhaps a year or so from now, the economists will say that "Bernanke saved us all. Hail Bernanke!" ... but that would probably only be heard on an election year. A few years or a decade later, the new economists will be talking about how disastrous the policy has been because public sector consumption choked off the only real driver behind economic growth: private sector investment.

I also think that the average person "gets it" and they know that there must soon be a day of financial reckoning, which is why the "stimulus" program is not boosting consumer confidence or prompting businesses to hire and reinvest nor is it spurring banks to lend. Everyone is waiting it out and bracing for the coming financial reckoning: higher taxes, increased government control of the economy, socialized medicine and eventual forced austerity for unfunded entitlements. In other words: European style socialism.

Further Reading:

Peter Schiff, Forbes: Austerity Vs. Stimulus, The New Ideological Divide
Alan Greenspan, Wall Street Journal: U.S. Debt and the Greece Analogy
Alan Melzer, The Wall Street Journal: Why Obamanomics Has Failed

30 yr bond price breakout

2010-06-29T10:59:00.000-07:00

As a follow-up to Treasury triple bottom breakdown, I've been watching bonds again lately. I watch bonds because the bond market is about double the size of the equity market and the players are mostly institutional investors, the smart money. Moves in the bond market often precede moves in the equity market. Let's look at the chart below for example:

As you can see, the 30 year bond price has traded in a range but has broken out of that range when things aren't right in the world. Most recently, the price has bumped up against resistance several times before breaking through. We see a similar situation with the 10 year yield (visit this link for clickable chart).

Back in April, I was saying that the market was looking overdone and that there were bearish signals. A comparison of the 30 year bond and the SPX (below) support that same dire prognosis. At that time, bond prices began to rise, a clear indicator that the smart money was seeking safety. Likewise, at a time when I was saying sell the rally, the smart money did exactly that and sold equities to weaker hands while smart money went to bonds. I suspect that we'll see the right shoulder of the "head-and-shoulders" pattern and have another climb upward in equities (failed H&S). Look to the long bond for clues.

How to make the USA #1

2010-06-28T22:47:00.000-07:00

China is poised to surpass the U.S. in manufacturing next year. Fred Smith, FedEx chairman/CEO, provides some insight on how to keep America in the top position.

Privatize Social Security

2010-06-19T15:36:00.000-07:00

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The problem:

One of the most vexing economic and financial bombs we face is the $100 TRILLION unfunded liability of Social Security and Medicare. It's a gigantic Ponzi scheme in which those who got in early get a pay out while those who get in later will never see a dime. Like all Ponzi schemes, it will collapse as soon as inflows start to exceed outflows. This is where we are today; at the verge of collapse. Yes, we can postpone the inevitable by extending the retirement age, by reducing benefits and by adding a means test ... but it's still a Ponzi scheme that must inevitably collapse.

We see the devastating economic consequences happening in Europe today because of the same Ponzi entitlement systems, yet we plunge headlong into the same economic black hole as Europe ... "W" heaped onto the entitlement dung heap with the medicare prescription give-away and "O" with the nationalization of the financially disastrous MittyCare. The system will collapse within the next decade if we do not bring about a fundamental shift in the entitlement paradigm. We must return to a model of individual responsibility and move away from this cradle to grave nanny state that has proven a failure time and time again. Pay-as-you-go social security systems just don't work because everyone tries to minimize what he puts into the system while trying to maximize through political pressure what he can get out of it. That's why these types of plans are going bankrupt all over the world.

Click to enlarge.

Isn't it just common sense that it's better for American's to actually save for their retirement instead of paying into this rip off? America desperately needs investment (which comes from savings), but instead, the government sponsors debt-driven spending, it discourages savings and it makes empty promises that the nanny state can't possibly provide. What's worse, we are relying on foreign governments to fund our deficit spending to keep the Ponzi scheme alive and we are forcing our citizens to put their money in the Ponzi scheme.

The solution:

It will take a long-term commitment over a period of thirty years to correct this problem, but I assure you that there is a proven solution at hand that does not require us to default on our promises to prior generations. The retired will not become indigent and will not go without medical care. Eighty-five percent of the population will be able to save for their own retirement and medical care. The poor will not go without basic sustenance. It will require education and real change; not the false hope and change we got with the current Congress and President. It will require political foresight, courage and real leadership; something severely lacking in this Congress and this President.

Two prominent Economists, José Piñera (video below) and Milton Friedman, have proposes the solution of privatizing Social Security as an alternative to the bloated government programs which amount to nothing more than a Ponzi scheme involving a fictitious “trust fund”. Their proposal is to convert all current Social Security liabilities (for those already retired) to treasury bonds equal to the present value of future benefits. For everyone else yet to retire, it would be an obligation due when the individual would have been eligible for benefits, minus the present value of the individual’s future SS tax liability (because they would no longer pay SS taxes).

In essence, everyone receives a Treasury bond instead of SS and everyone (yet retired) contributes to their own pension system going forward. In this way, all liabilities can be transferred to a private system while still meeting the promises made to the current generations. The unfunded debt (the bonds) are paid for, when due, by taxing, borrowing, creating money or reducing government spending. The level of liability will be a magnitude smaller because the younger you are the smaller the government liability. Future generations can no longer lay claim to the promise made to the current generations. Only the truely poor can draw on the public system, while everyone else must save for their own retirement. It eliminates a bad tax, a regressive tax on productivity and labor and it creates real savings and investment, not a Ponzi scheme. It would be an economic windfall, as it has been for Chile.

Debt Implosion

2010-06-14T21:06:00.000-07:00

I'm an avid reader of practically anything related to finance, politics, economics, or markets. I easily spend 4 or 5 hours a day reading things that would probably make the average person's eyes bleed or make them go into comatose state. It's a sick obsession, I admit, but I'd rather go through life with my eyes open than in blissful ignorance.

Click to Enlarge

One particular theme that I've been following for a better part of a year is the end game with all this debt overhang ... states, banks, sovereigns, consumers, commercial real-estate etc. All that debt - with very few exceptions - is being transferred to the backs of the tax payers (courtesy the State and Federal governments) via bail-outs, Freddy, Fanny, the FHA and now the poorly managed public sector pension funds are also being hoisted onto the tax payers backs. Probably one of the best summaries of the whole cycle is illustrated by Gorden T. Long. Click on the image above to get a better view.

I read something alarming today about the Illinois Teachers Retirement System which is engaging in opaque, over the counter credit default swaps (CDS) and interest rate swaps. If you're not familiar with these derivatives, they're the highly speculative financial instruments that sunk every "too big to fail" Wall Street bank last year. That's right folks, some genius decided that it was reasonable to gamble the pensions of teachers, police and fire-fighters on CDS betting on the debt of AIG, GMAC, Panama, Mexico and Brazil. The fund hemorrhage money in 2009 and is still likely hemorrhaging as sovereign debt interest rates spreads are widening of late. The fund lost 11.5% in 2009 while the S&P averaged 26% in gains. Truthfully, a chimpanzee pointing at stocks randomly on the Wall Street Journal stock page could have done better.

Considering that this is Obama's home state, and considering that a large portion of his political support base are the unions, you can bet that this pension fund will be bailed out (the fund is currently 61% underfunded). Even if the fund doesn't get bailed out, all those public sector workers will be retiring with no pension ... and we'll have to support them with tax dollars, some way, some how.

Enter NJ's pension fund that shells out 600M each month with only 100M being contributed to the fund by employees. It's only a matter of time before that fund implodes also. Another bail-out.

Once again, the implied government backstop to fix everything that goes wrong is what fosters irresponsible risk taking. It's gambling with other people's money with absolutely no down-side to the gamblers and unlimited down-side to the tax-payers. Are your eyes bleeding yet? Sorry about that.

The Wild $TRIN

2010-06-10T21:42:00.000-07:00

The $TRIN is going through what must be record extremes. The P+F chart below filters out the noise a lot to give you a better idea of the past extremes for this indicator. The market appears to be extremely over-bought on relatively low volume. Friday's market action is either going to be a rocket launch to the moon or a massive sell-off. I'm betting the latter.

Economics 101

2010-06-08T08:28:00.000-07:00

How would you answer these basic economics questions?

Do restrictions on housing development make housing less affordable?
Does mandatory licensing of professional services increases the prices of those services?
Is the standard of living higher today than it was 30 years ago?
Does rent control lead to housing shortages?
Is the company with the largest market share a monopoly?
Do American companies exploit their employees in third-world countries?
Does free trade lead to unemployment?
Do minimum wage laws increase unemployment?

How you score on this quiz may have a lot to do with whether you're a liberal or a conservative. Self-identified liberals and Democrats do badly on questions of basic economics.

For the correct answers, read this article in the WSJ.

Russell Rebalance

2010-06-07T12:19:00.000-07:00

Expect high volumes and volatility on Tuesday, June 29th due to the Russell Rebalance.

Market bottom or did investors quit?

2010-06-07T06:19:00.000-07:00

Take a look at the TRIN (NYSE - Short-Term Trading Arms Index). This is a somewhat complex indicator. See a complete description here. I find it useful in assessing whether or not a given day is over-sold or over-bought when trying to time an entry or exit once you are convinced of the overall trend of the market. Note below that Friday's market action was massively over-sold while the $CPCE (Equity Put/Call ratio) is not overly bullish or bearish. It either means that we've hit a market bottom or that institutional investors have quit the market. The next few weeks will tell the story.

Treasury triple bottom breakdown

2010-06-07T06:01:00.000-07:00

A notable occurrence in the ten year Treasury: We see a triple bottom and the beginning of a breakdown as the TED spread widens. TED stands for Treasury Bill and Euro-dollar or LIBOR in US dollars. The Ted Spread is the interest rate differential between the 3 month London Interbank Offered rate (LIBOR) in US dollars and the 3 month US T-Bill rate. We could see a collapse of Treasury yields soon, reminiscent of Dec-2008 (just prior to the financial collapse).

Losing money on leveraged funds

2010-06-04T11:40:00.000-07:00

Question: How do you lose money on a leveraged ETF?
Answer: Hold it longer than the current trend.

These sort of ETFs suffer from a daily compounding which causes tracking error. As you can see from the chart below, had you held an actual Treasury note ($TNX) from Oct-2009 until Jun-2010, the NAV would have stayed the same, but you would have been paid approximately 1% to hold the note. Conversely, had you bought a reverse bond ETF, such as TBT, you would have lost approximately 10% in NAV and would have been paid 0% interest for holding the fund.

If the ETF tracked well, then the ratio of TBT/$TNX should remain fairly constant. What we see instead is a steady erosion of value due to daily compounding. The leveraged ETF should only be used for short periods of time while a trend is active and volatility is moderate to low.

Commodities bear

2010-06-02T20:50:00.000-07:00

A report from Bloomberg on Monday tells about a bearish commodities signal. The Reuters/Jefferies CRB Index of 19 commodity futures ($CRB) are considered more accurate than other futures indexes because about half of the commodities in the CRB are traded on exchanges not used by speculators. The decline of the commodity index signals that global industrial growth has peaked. A decline in price and demand for commodities signals an economic slowdown and possible deflation.

A collection of charts

2010-06-01T08:21:00.000-07:00

I added a new tab called "Charts".

Then and Now

2010-05-30T13:01:00.000-07:00

November 18, 2009
BEIJING -- President Barack Obama says he's worried that spending too much money to help revive the economy could undermine a fragile U.S. recovery and throw the economy into a double-dip recession.

That's when the economy begins to recover briefly from a recession only to be dragged back under. Obama told Fox News in an interview Wednesday that his administration is weighing tax breaks that could encourage businesses to begin hiring again.

But he added that it's important to recognize that if the nation keeps adding to deficit spending through tax cuts or more stimulus spending, at some point people could lose confidence in the U.S. economy and that could "lead to a double-dip recession."

Gold: $1,135/oz
Dow: 10,700
U6 Unemployment: 22%

May 25 , 2010 (6 months later)

The US money supply plunges at a 1930s pace as Obama eyes a fresh stimulus package. The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history.

The Obama administration made a strong plea to Congress on Monday to "grit its teeth" and pass up to $200B in new spending measures – dubbed the "second stimulus" by some economists.

Damned if you do, damned if you don't.

Gold: $1,185/oz (up 4.4%)
Dow: 10,030 (down 6.3%)
U6 Unemployment: 22% (unchanged)

Free Market Rules

2010-05-30T10:45:00.001-07:00

I had a debate with one of my imported socialist co-workers today. I like to invite a socialist to Starbucks once in a while and offer to pay. They always accept, of course. I do this when I'm in the mood for a good argument.

Anyway, the reason my Socialist friends like to argue with me is because they think that I (and Sarah Palin) run the Tea Party. My socialist friends have all sorts of reasons why the Tea Party is bad, wrong etc. I find it intriguing that they are so animated whenever the topic comes up. I think the reason they are so animated is because they see the change blowing in the wind and it makes them uncomfortable. They can't imagine a libertarian view. It makes them shutter to think that individuals decide what's best for themselves and that they be required to live with the consequences of their individual decisions. It smacks of an elitist mentality that people don't know what's best for themselves.

The arguments typically center around a few themes: Big government, free markets and individual liberty/responsibility. Today, the argument was about free markets (with a dab of big-government on top).

Free markets defined: The ability for individuals to freely exchange goods and services without coercion. Examples of coercion are theft, falsehoods, force, monopolies and other forms of unfair advantage. In essence the governments job is to enforce contracts, punish theft and falsehoods and to otherwise keep a level playing field. Each man competes with the other, enjoys the fruit of his labor and bears the burden of loss when he fails. Government is not to become a coercive force itself by favoring one man over another or interfering with the profit/loss, risk/reward balance of free markets..

My socialist friends - like a lot of Americans - are of the opinion that the free markets are unregulated markets, that the free market is what failed and government is what saved the economy. Nothing could be further from the truth. Heavily regulated markets across the globe failed because those governments sought to reduce risk of loss by acting as a financial backstop (an implied bail-out) which caused moral hazard. Big business bribed big government to put the risk of loss onto the tax payer and then proceeded to gamble, having no risk of their own.

Somehow, in my socialist friend's mind, total regulation of markets is not socialism or statism. They don't make the connection that statism is what compelled them - who are the best and brightest in their fields - to move themselves and their families to America. It's not unlike the Californians who leave their bankrupt, over-regulated, over-taxed state for a better life in neighboring state, but immediately set about instituting the same failed socialist policies that collapsed their native state.

I argue that any failure in the free market can be directly connected to some form of coercion, often state-sponsored coercion. Furthermore, the best regulator is risk of loss. All other forms of regulation are inferior, in my opinion. The government can't prevent failures or prevent loss. They've proven this time and time again. They can, however, ensure that risk takers live with the outcomes, both good and bad.

Let's take the BP oil disaster for example. If BP causes an environmental disaster, then BP pays for it. If the cost of cleanup puts BP out of business, so be it. It serves as an object lesson for those who follow. Why not require BP to put up a sizable bond before being allowed to drill in deep water? This puts the responsibility and all the loss on BP. What does our statist government want to do instead? They want to tax oil companies so that they can create a big bail-out fund for the next environmental disaster. It will just create moral hazard like the implied bailouts of banks did ... and who really believes that the government will put the money aside for a disaster instead of spending the money on pet projects instead?

The reverse invisible hand is at play whenever the government deviates from free market principals and tries to minimize risk of loss or otherwise coerces the market.