Archive - Nov 19, 2010

For those who wrongly believe that the biggest real estate bubble in the world is in Manhattan, the following may come as a surprise: according to Dylan Grice, in central Hong Kong, a 400 sq. foot property recently sold for HK$14MM, or about $1.8 million: an insane $4,500 per square foot. And that's just the beginning. Yet, as we have started to speculate recently, is this precisely the goal of Ben Bernanke - to create pockets of silly inflation within China so that the country is eventually forced to unpeg the CNY? If so, this is a huge gamble, as the bulk of the country still has far more slack than America ever can. And while China, and the bulk of its wealthy citizens, continue to pretend there is no bubble (created by the same free credit mechanism that results in the 2008 near-death of the US economy), has, as Dylan muses, China "already lost control? And if so, who's to say what will happen if the asset inflation goes into reverse? Maybe when the authorities engineer the slowdown they desire and tell investors it's safe to buy again, those investors  won't want to buy. In which case a hard landing shouldn't be beyond the realms of imagination." Grice then proceeds to explain the obvious, namely that the fall out of the inevitable collapse of the Chinese bubble will be unprecedented, as not only the EM world, but the developed economies have all hitched their fates upon the successful continuation of the Chinese bubble - the same bubble Bernanke has to unwind to get the much desired CNY reflation. Grice says "Go to Ireland and ask them how they feel about bubbles. They'll tell you a bubble is a curse, not a blessing." Of course, Ireland is about to be bailed out. Who, however, will be able to bail out China when the overheating economy gets it trillions in loan supports taken out? That one not even Chairman Ben will be able to rescue...

A topic we covered extensively in the past makes a second appearance, this time courtesy of Abigail Doolittle and The Weekly Peak, whose weekly musings focus on the much fabled ratio between the price of gold and silver. Some observations:

• 323 B.C. – The ratio stood at 12.5 upon the death of Alexander the Great.
• Roman Empire – The ratio was set at 12.
• 12th to 17th Century – The ratio was around 12.
• End of 19th Century – The nearly universal, fixed ratio of 15 came to a close with the end of the bi-metallism era and England’s attempt to demonetize silver and conceivably because the country had little of the precious metal.
• 1980 – At the time of the last great surge in gold and silver, the ratio stood at 17.
• 1991 – When silver hit its lows, the ratio peaked at 100.
• 2003 - 2007 – This part of the bull market in silver caused the ratio to drop to 45 from 80.
• 2008 – The ratio rose back to 80 on the Great Recession.

PG: A company that earns above its cost of capital (positive Economic Margins) and is growing its asset base is considered to be following a wealth-creating strategy. Back-tests have proven these companies to be more likely to outperform those companies following a wealth-destroying strategy (negative Economic Margins and growing assets). PG also is trading below it's intrinsic value.

RANsquawk US Afternoon Briefing - Stocks, Bonds, FX etc. – 19/11/10

Last week, the US Treasury issued $16 billion in 30 year notes due 2040 (CUSIP: 912810QL5) which was one of the ugliest 30 Year auctions in recent history (Santelli grade: F), and which we speculated may be a dud as PDs were not aware of what the POMO schedule would look like, and that in turn it would likely be promptly refunded back to Bernanke. We covered that issuance in detail. Today, Brian Sack just completed a $2.2 billion POMO focusing on bonds in the 17-30 bucket, at a relatively high Submitted to Accepted Ratio of 5.1x (and yes, the higher than median ratio may be an indication why stocks are red again as explained before). What is most notable is that the last bond on the accepted list (highlighted below), of which the Fed monetized $24 million worth, is CUSIP QL5: the 30 Year bond auctioned off last week. And so the shell game continues.

Skip General Motors, which is getting over inflated through a combination of media and government hype. Today Toyota, the world’s largest car maker, has been slammed by the perfect storm. Toyota has become the BP of the auto industry. Since the company is Japan’s largest exporter, it would benefit greatly from any weakness in the yen. Buy when there is blood in the streets. (TM), (FXY).

Atlantic Capital Management, whose previous analysis on why the US Economy is caught in another perfect storm (link) was spot on, presents its latest special report focusing on the "desperate" Fed, and why it believes QE2 "Is a hail mary toward the wrong endzone." The must read report, has three parts explaining why spending is about sources, not cost, the differential between wealth and the Chinese imbalance, and the last part emphasizes the Bernanke put, i.e., how there is no longer real risk in the decision-making process. For those who enjoy flipping to the last page of a book, here is the conclusion: "QE 2.0 moves us further in the wrong direction. It removes even more market enforcement in favor of political hocus pocus, “nobody loses” nonsense. To return to sustainability and longterm growth, discipline must be enforced on everyone, including the Fed...As to the consequences of QE 2.0, we believe this new monetary amplifier will produce exactly the wrong responses for the reasons contained within this report. It’s as if Chairman Bernanke has lined up in the wrong direction, ready to heave one to the wrong endzone. The only question is whether the rest of his teammates will tackle him before the damage is done, and the game lost."

Marc Faber was on Bloomberg TV sharing his thoughts on China's 5th RRR tightening in 2010. While the man whose on the ground perspective affords him a good sense of what is really happening, does not anticipate major adverse developments out of the recent round of tightening posturing, he does warn that unless China manages to control commodity inflation, things could get ugly, essentially reiterating what Albert Edwards said yesterday. "Inflation is a dangerous situation everywhere in the world. I think in general that Consumer Price Indices published by China and the US do not reflect the real cost of living that households in these countries have. In Emerging Economies it is worse in the sense that if you have a per capita income of $1000 per year, food accounts for 50% of our expenditures... Even if China tightened, interest rates are still far below the true rate of inflation, and I spoke to a lot of people in China - my view is that inflation in China is running at 10% per annum." On Bernanke's overnight defense of his failed policies: "All I would say is that the problem of the world is that the US overconsumed and spends too much on consumption, and as can be expected some currencies didn't want their currencies to appreciate too much. I think that China and the US are on a collision course, both economically and politically." In other words, our speculation that China and the US are playing a global game of chicken is validated, the problem is that billions of people will suffer no matter who blinks first.

GM is now officially threatening to break the IPO price, less than 24 hours after breaking for trade yesterday. The stock had dropped to as low as $33.11 before a spurt of buying by DMM GETCO pushed it higher. The question of whether the HFT firm can internalize what has become an onslaught of selling is open. We can only hope GETCO has sufficient redundancy to absorb the massive volume, which at last check was 36 million shares and jumping: it appears GM will once again dominate NYSE volume. Should GM drop further from here, the world's greatest IPO will need some serious cheerleading by Phil Lebeau to rekindle America's hope in the company that went bankrupt, and was saved by taxpayers a year ago. And the one aspect of the stock that nobody seems to be mentioning is that GM is now a China play: with more cars sold in China than in the US, should China persist in its tightening, GM will be among the first casualties as excess liquidity redemption hits car purchases as consumers are forced to save all their money for more relevant purchases... like food.

Families stay huddled in their McMansions, protected from phantoms by state of the art security systems. Their interaction with the world is through their electronic gadgets. Neighborhoods of cookie cutter 4,000 sq ft mansions appear deserted. Human interaction is rare. Happiness is in short supply. As I sit in miles of traffic every morning during my soul destroying trek to work I observe the thousands of cars, SUVs, and trucks and wonder how this can possibly work when the peak oil tsunami washes over our society in the next few years. Then I reach the bowels of the inner city and my pessimism grows. This concrete jungle is occupied by hundreds of thousands of uneducated, unmotivated, wards of the state. They live a bleak existence in bleak surroundings and depend upon subsistence payments from the depressed suburbanites to keep them alive. How will they survive in a post peak oil world? They won’t.

The plight of Chinese company RINO International is about to be over. The company has just filed an 8-K which essentially signs its own death sentence (see below). This is a stark reminder of what happens when one deals with companies going public in the US, yet subject to regulations and accounting rules of a different time and place, and we are confident that the recent onslaught of Chinese IPOs on the revenue strapped NYSE (hint: listing fees) will prove to be a complete disaster for everyone who bought into this most recent market top tick. The RINO case study will soon create a cottage industry of micro funds seeking to make massive profits by shorting then destroying the credibility of every Chinese company to have gone public on the NYSE recently. Our advice: get the hell out of dodge. We will shortly present a list of all the sell side analysts who should be summarily fired for recommending a Buy rating on this stock as recently as a month ago (yes, that include Canaccord).

I suspect many in the mainstream academia haven't realized what QE2 is. It is the last use of the dollar's reserve currency status, intended or otherwise. In a fiat currency system, inflation should be the only risk, because fighting deflation should be trivial -- just print money. This is a fundamental advantage of a fiat system over the old gold standard. Unfortunately for the US, the dollar's reserve status means the geopolitical border is not the dam holding the water as in other countries. As Fed pours in more water, it leaks right out to lowlands (good investment destinations) all over the world. Given the current economic prospects in the world, the result is that QE2 cannot stoke inflation in the US, but causes very unwelcome interference in exactly the other places in the world where inflation is a big concern.

With everyone speculating what China's actions may mean, we go to one of the few true experts on the world's most populous country - CLSA Chris Wood (author of Greed and Fear). "The reality is that, for now at least inflation ex-food remains remarkably tame based on CPI inflation data. Still the political sensitivity of food means the PRC is making executive decisions, such as imposing price controls on specific food items or threatening to lock up commodity hoarders. This makes investors nervous. Such measures have put a policy risk on the commodity stocks in the same way that policy risk has capped the Chinese property stocks over the past year and more. Still GREED & fear would use this correction to add to positions in Chinese bank and insurance stocks which would seem to be the beneficiaries of higher interest rates in China. As for monetary tightening in China it is important to remember, amidst the present noise, that the key tightening measure in the command economy system is the loan growth quota not interest rate hikes or increases in the reserve requirement ratio. For now CLSA is estimating that the new loan quota for 2011 will be reduced relatively marginally from Rmb7.5tn this year, or 18% loan growth, to Rmb6.5-7tn or 14-15% loan growth."

I love big arbs. It means markets will be moving.

• Cowen Scorned as Irish Mourn Loss of Sovereignty With Bailout (Bloomberg)
• Irish Bailout May Unleash Vigilantes on Portugal (Bloomberg)
• Spain and Portugal rule out rescue packages (FT)... until they rule them in
• Hong Kong Said to Plan New Property Curbs; Stocks Decline (Bloomberg)
• Andy Kessler: What's Really Behind Bernanke's Easing? (WSJ)
• In Shanghai, prices fly high (Reuters)
• Heat Stays on California $10 Billion Note Offering (WSJ)
• Special report on SAC's "information arbitrage" strategies  (Reuters)
• Pimco Said to Seek $1 Billion to Buy Troubled Assets From Banks (Bloomberg)