Tuesday, November 25, 2008

Things that make you go hmmmmmmm...

Does anybody find it ironic that the Federal Reserve hired Michael Alix, the former Chief Risk Officer from the now-defunct Bear Stearns, to manage the Fed's risk profile? What on earth did he do right to manage Bear Stearn's risk--considering they were insolvent? I guess on Wall Street at least, losing money is a badge of honor and gets you fast-tracked into a top position within the government.

Also, what makes former investment bankers selling collateralized debt obligations (mortgage-backed securities) and credit default swaps competent fund managers? Many are out on the streets, and are now starting hedge funds, charging 2/20, I'm sure. It's astounding...fool me once, shame on you...fool me twice, shame on me...

Friday, November 21, 2008

What to do going forward (part 2)

While I will agree with you on the metals play, you jumped in a bit early (not a sin), as hedge funds are unloading everything to raise cash--stocks, bonds, commodities, their first-born, etc.You're down 10%, but again, not a sin.

What I do object to is your recommendation of speculative mining stocks. Some of these junior mining companies could run out of cash unless the coming boom occurs soon, which it may or may not. An investor would lose all or much of their investment (cash-poor mining stocks sometimes agree to be acquired, albeit it at a low price). It would suck to make the right call on the direction of metals, and but lose money because the mining company ran out of cash. So yes, on mining companies with cash, no on the speculative plays.

I do like your call on coins and some of the larger gold and silver mining companies--as long as they earn a profit and are well-capitalized (have lots of cash).

As for peak oil, that call proved to be disastrous--or really early, as there has been demand destruction due to a worldwide slowdown. An alternative energy play is natural gas MLP's, which are currently yielding double-digits (all-time highs). Their prices have been battered, but I like the bigger ones who are paying out dividends to unitholders, as they must from positive cash flows. I don't mind waiting for a turnaround if I can earn 20% on my money--most of it tax-deferred. Crude oil is sensitive to the worldwide economy. Natural gas is less sensitive to the transportation and manufacturing industries. However, people need to heat their homes, and cook their food. And more fleet vehicles are being converted to natural gas, as it burns cleaner. But like I said, earning 10-20% is better than earning 1%. When energy prices do recover, these MLP's will appreciate as well.

What to do going forward (part 1)

There's nothing confusing about this: Dave and I just made a ton of money today. Trust me, it's just the beginning. I'm not even referring to the stock market. As I said earlier, the buyers and sellers will continue to fight each other on where the exact bottom will be. Stocks will trade inside a range, albeit it a wide range, due to high volatility. Meanwhile, contrarians like he and I will be adding to our positions geared towards inflation and financial meltdown. Savvy investors will eventually see it, then CNBC viewers, and by the time the mainstream audience catches on, gold will be testing their all-time highs.

When you print money like toilet paper, something has to give. Don't just look at the $USD/gold relationship. Look at the price of gold from a foreign currency perspective. From their standpoint, the price of gold is at an all-time high already, because the $USD is temporarily gaining strength due to the flight to quality, as sovereign funds, hedge funds, mutual funds, and private equity firms face redemptions from investors selling. More banks and financial institutions will go under as a result. Companies will go bankrupt, due to lack of liquidity and lack of access to credit. If people insist on owning shares, the only ones I would trust are Wal-Mart, McDonald's, Coca-Cola, Berkshire Hathaway, Altria, ExxonMobil. Focus on dividends, cash flow, cash position, and ability to borrow. Microsoft will be able to tap into the corporate bond market at 2%....which is better than what the US government will be able to borrow at. Think about what I just said: Microsoft will be more credit-worthy than the US government.

In light of all these federal government bailouts, and solvency issues with banks, financial institutions, insurance companies, autos, airlines, etc. has anybody even thought of whether the government itself will be solvent? They continue to print money at a rate of $1 trillion extra a quarter. That devaluates the local currency. Once people wake up to this inflationary scenario (where the US Treasury will have to borrow at 8% or above), one where the $USD deteriorates, gold and silver will skyrocket. Right now, the markets are focused on deflation. That will change--it's only a matter of time. And when you have disinvestment AND inflation, you get stagflation like we experienced in the 70's, only this time, the overshoot will be even more severe.

What happened?

The stock market, and pretty much every other assets are plummeting due to hedge fund, mutual fund, and private equity firm redemptions. Investors are bailing out, so these funds have to sell assets--any good assets to raise cash. They can't sell the bad assets because no one wants them. So they are unloading good assets at low prices--that's why value players are salivating, but they keep getting burned because assets at cheap prices are getting hammered and getting even cheaper. This tug of war between bottom fishers and forced asset sellers is what's causing the high volatility. Overall, tho, the sellers are winning, as they are panic selling in droves, swamping any brave buyers. Eventually, these buyers lose out (at least in the short term), as even the savviest value buyers are seeing their entry points as being too early and too high, despite metrics that suggest they are good buys. Ultimately, over the long-term, these value buyers will be proven correct, but for now, guys like Buffett and Soros have seen their positions drop by more than 10-20%, despite buying assets that have already dropped more than 50% already.

For example, if a solid company's share price has already dropped 80%, it may seem cheap. It may be, but that doesn't preclude it from dropping another 50%. Let's say a stock is at $100 last year during its peak. It is now at $20. A Buffett buys at that price, thinking he's getting it at a bargain. He may be right (based on projected earnings growth, or more correctly, discounted cash flow), but that doesn't mean the stock won't drop to 10 before bottoming out, say next year. Ultimately, if the stock is worth $50 a share, Buffett may ultimately win out (he usually does), but only if he has a long-term view. While he may be annoyed, and since he's got plenty of cash, he can wait it out.

Realize that the fixed-income market dwarfs the equities (stock market)--that's why the subprime mortgage debt bomb obligerated everything around its wake. I wrote a quick email to some folks recently:

"That's not entirely correct. Derivatives allowed investment banks to transfer that risk to shareholders and get it off their books. When default rates on sub prime mortgages reached inevitably high rates, the credit default swaps (CDS) blew up, as they insured the sketchy collaterized debt obligations (CDO).

These CDS's are basically contracts which insured these mortgages against default--in this case, highly-risky subprime mortgages to marginal borrowers. The problem was that insurers like AIG didn't charge enough premium to insure these mortgages, as everybody assumed California real estate prices would always go up, and that few borrowers would actually default. With home prices/income ratios above 10, this assumption was unsustainable. And because these derivatives were highly-leveraged ($1 could control $40 or $100 due to Wall Steet's repackaging of said debt), if those assumptions turned sour just a little bit, whatever little equity put up as collateral disappeared. And once the selling of assets to unwind from those positions began, the vicious spiral just fed upon itself, as everybody had to de-leverage from their overly leveraged positions. It became a Category 5 game of hot potato, and the investors (hedge funds, pensions, institutional money) got burned, while chasing the high yields during good times.

Wall St. did a great job of selling this "AAA" paper as non-risky, when they were extremely speculative. The ratings agencies were unknowing perpetrators of this shell game. Wall St. repackaged these @#@% loans, and the ratings agencies gave it their blessing as low-risk, investment-grade securities. What compounded the problem is that some of this paper was created without even any mortgages to back them.

Derivatives by definition use leverage. It can be useful for hedging strategies, but hedge funds didn't use them as hedges--they used them as levers to squeeze out more returns. When the bets turned against them, they had to sell assets to raise cash as investors headed for the exits. This de-levering is causing markets to tumble.

I could go on ad nauseum, but I think you get the picture. I don't worry about what happened--I was able to avoid most of the roadkill, as I was out of the market in June. I am concerned about what's going to happen next, and I'm afraid the worst is ahead of us. We are going to see a carnage unseen since the Great Depression, as the unwinding of positions is not over yet--not even close. Thankfully, I've got a strategy in place for me and my clients which will enable us to not only survive this crisis, but also profit handsomely from it.

Without going into details, it does involve certain currency plays, financial institutions here and abroad, and various asset plays, including equities (surprisingly). More shoes will drop, and there will be bigger shocks and bank failures, some unfathomable only a few months ago. I predicted GM would be insolvent as far back as two years ago when people thought I was crazy (all documented in my blog). Last month, CNBC splashed it on their headlines, and now CNN has it on theirs.

I can send you a link to my blog, as well as what to Google. I will not do the research for you, but I will point you in the right direction. I will tell you the strategies will not be mainstream or conventional, but then again, conventional hasn't worked, has it?

I will give you this thought in case you think I am ringing alarm bells unnecessarily. Everybody is bitching and moaning about a $700 billion bail out (which is less than $1 trillion). Recall I mentioned CDS's as basically insurance--only they were labeled by Wall St. as "swaps" in order to avoid regulation (insurance contracts are heavily regulated, and you can't pile leverage on them). They were creating these insurance contracts with no regulation, and hence, no reserves to cover them. Guess how many swaps were written, and how big the derivatives market is? Some are predicting over $500 trillion! (A definitive number is difficult to calculate since these products were so complex, were sold so many times, and generally not transparent). In other words, there's no bailout that will mitigate this deleveraging. The current band aid will only prolong the process, but the perfect storm will come down upon us--soon."

As an edit: we've lost $10 trillion in equities market capitalization (net worth) in the last two months. That figure will seem minuscule when these derivatives blow up in our faces, and when Paulson et. al will no longer be able to hide it from the public. Read his past comments over the past year and a half. You will see he has hoodwinked us all along.

Monday, November 10, 2008

The next shoe to drop...

We've seen the subprime mortgage crisis spill over to the whole residential mortgage industry, causing property values to plummet in many regions. Collateral debt obligations and credit default swaps turned sour have caused a further erosion of asset values and balance sheets across the globe. This has caused a run on several investment and commercial banks, most notably Lehman Brothers and Washington Mutual, respectively. This cascaded over to the stock market, leading to breath-taking declines across all sectors, including industries in hard assets, like oil, natural gas, gold, and the other minerals and commodities. While the Fed dropped its funds rate to 1.0%, and the Treasury turns on the money spigot, we anticipate future inflation. However, due to massive investor redemptions at hedge funds and now mutual funds in an effort to raise cash, individuals and institutions alike are scrambling to de-lever their precarious financial conditions. Deflation--not inflation, is the current concern. The R word (recession) is not a question of if, but how deep and for how long.

So the worst is over and the unknowns are out on the table, right? Wrong. Just as many teaser residential loans have been re-setting, causing a barrage of foreclosures, the commercial real estate market, which has held up relatively well up to this point, is now in real danger of falling off the precipice as well. As companies announce massive layoffs, and as consumers hunker down to save for a rainy day, companies have lowered earnings projections (hence, shares of equities have plummeted). These conditions will be disastrous for commercial real estate values, which are ultra-sensitive to economic conditions. Expect more bankruptcies, vacancies, and foreclosures in the commercial real estate space.

Thursday, November 6, 2008

I wrote this letter before the day after...

I wrote this after Obama was declared the winner in the Presidential race:

Obama will perpetuate the welfare state, as people seek handouts instead of being productive members of society.

I agree with all you said about Obama--he's charming, articulate, intelligent, and perhaps even well-meaning. Jimmy Carter was the brightest President we've ever had. Look what happened when he was in charge. Granted, he had a speech impediment, but Obama's ideas are actually more dangerous.

My advice right now is to put your money in tax-free vehicles, whether muni bonds or properly structured, maximum-funded life insurance, or the Mississippi Go Zone. For Growth, buy Wal-Mart and McDonald's, as the strong will get stronger. Natural gas pipelines master limited partnerships are down 80% from their peak, yet reporting recording earnings. And meanwhile, they're giving 20% dividends annually while we wait for a rebound. 200-300% returns won't surprise (between the quarterly dividend and share appreciation), and it's not some speculative high tech play--it's an investment in a gas pipeline company--people will still need to heat their homes and cook, even if they turn the thermostat down. Plus, more municipalities are converting their fleet vehicles to natural gas, as they burn cleaner. T. Boone Pickens made a fortune in oil, then natural gas, and now alternative energy. Bet WITH him, not AGAINST him. Two gas plays I've bought have ex-dividend dates of Nov. 10, so it's too late to buy (it takes 3 business days to settle positions)--there are others, or I will wait another 3 months for the next window.

Kinder Morgan is the safest play, but their dividend is only 6% at today's prices--still solid. My buys have higher yields (20% and 14% dividends, respectively). Since it's an MLP , all its cash flow and earnings go directly to unitholders (me). These MLP's should double within a year, but even if they are flatlining, I still earn the dividend. Disclaimer: this is not a recommendation for any single commpany--these are shares I purchased myself or am considering purchasing.

If you wanna be lazy, just put it in an orange account earning 3%, but realize the big, bad wolf of inflation is just around the corner. The Treasury is printing all kinds of dollars, trying to save this sinking ship, and it's going to make our currency worthless, much like the 70's, when gold, oil, gas, and every other commodity skyrocketed. It's not a matter of if, it's a matter of when. The market will finally wake up to it, and you're going to see a mass exodus OUT of the stock market and real estate markets, and one INTO hard assets.

Meanwhile, watch a lot of TV, read a lot of books, work out, surf the internet, because doing anything else will be expensive.

Yesterday's rant:

Well the markets certainly confirmed my suspicions that Obama is not the answer, even if the average person wanted a "change", as the Dow Jones dropped almost 500 points yesterday. Usually, a change in regime brings hope, a renewal of faith, and optimism, which people are holding on to. But the real money is saying "I don't think so". They're saying growth will be negative or non-existent for years, our future looks grim, and so do our children's and grandchildren's, as we sock them with future taxes on money we spent that we didn't have.

I was wrong--GM lost $6.9 BILLION last quarter--much worse than even the most pessimistic projections. Their collapse is inevitable, as even a bailout by the governement won't help--neither will a merger with Ford or Chrysler.

Hell, at this pace, the US government will be out of business this next decade. At which point, the gun enthusiast with 50 guns will seem prescient instead of crazy.

The Obama un-rally....

As predicted, the market tanked as the Presidential race is over, with Obama being the victor, but the US economy being the loser (this is not an endorsement for McCain). The market is basically showing no confidence that Obama will succeed in stewarding our economy out of this financial crisis. The markets are living down to their negative bias of the President-elect who has repeatedly stated he wants to tax our way out of this slump. History shows it has never worked, and it won't work again. Based on rhetoric, the Obama regime will look more like the Carter years than the Clinton terms--only Obama is inheriting a much worse economy than the other Democratic Presidents.