Archive - May 2011

The confirmation of George Soros ETF gold sale has again garnered much media comment. Soros’ $28 billion fund decreased its holdings of the SPDR Gold Trust, the exchange traded fund. Soros had bought gold to protect against possible deflation, though his fund now believes there is a reduced chance of such a condition, the Wall Street Journal recently said, “citing people close to the matter”. Should Soros and his fund think that inflation is now a greater risk than deflation then it is curious that they would sell all their ETF holdings. It is also curious as Soros is on record regarding having serious concerns regarding the outlook for the euro and the dollar and the dollar as reserve currency of the world. There is of course the precedent of other hedge fund managers , such as David Einhorn, who have also sold their gold ETF holdings but bought physical bullion in allocated accounts due to a concern about counter party and systemic risk. This would allow Soros to discreetly accumulate bullion away from the public and media spotlight that result from SEC filings. Paulson & Co., the $36 billion hedge fund founded by John Paulson kept its largest holding - $4.41 billion in the SPDR Gold Trust. Paulson’s belief in gold is seen in the fact that those who buy his fund can have their stakes denominated in gold rather than in dollars, meaning the value of their investment rises and falls with the price of bullion – lessening exposure to the dollar. Paulson, unlike Soros, is on record as having purchased gold to protect against inflation. PIMCO, the largest bond fund in the world, are also increasingly allocating funds to gold in their global equities portfolio. “The largest position in [our] fund is gold, which we think is a very good form of protection against what can go wrong,” said Anne Gudefin, PIMCO’s global equities portfolio manager, told Fortune magazine May 12.

A snapshot of the European Morning Briefing covering Stocks, Bonds, FX, etc.
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It's getting hot in here!

And now a little follow up into Pimco's TRF holdings and real risk exposure. In addition to the previously noted Pimco holdings in Euro$ position (delayed, as the fund does not disclose actual holdings on a monthly basis), below we present the fund's positions that contribute to a substantial negative dollar duration position, primarily contained in various swaps and swaptions. Whereas the fund's euro$ positions are primarily to hedge rate bets in the future, they do add to the fund's dollar duration, and for practical purposes would not lead to a negative DWE number in the TRF. The contributors to negative duration can actually be found in PIMCOs various synthetic holdings, primarily of the swap and swaption variety as seen on the chart below, which however is as of June 30. Since then the dollar duration equivalent of the TRF has plunged which certainly means that PIMCO, while perfectly allowed to do as it wishes with cash, has loaded the boat on swaps and swaptions. Lastly, since PIMCO is likely betting on a massive curve steepening move, this alone means that whether expressed in a DV01 or carry neutral basis, the firm may have a positive MW exposure while being substantially negative duration and thus risk exposure. One can think of it as two massive offsetting synthetic hedges: the euro$ leg on one side adding duration and the swaption/swap leg on the other, both of which are the true determinants of PIMCO's risk exposure and rate bet. What happens in the cash side is irrelevant: PIMCO can parade that it does not have one cash Treasury short, which would be technically correct, yet be massively short bonds. A comparison could be made to Goldman's declaration to clients that John Paulson was long teh equity tranche of Abacus. Yes, but he was also massively short everything above the equity. And the firm's misrepresentation of this nuance is what the entire legal case against it was based on. We doubt PIMCO will suffer a comparable indignity, however (perhaps at most one or two LPs pulling their capital).

Asset quality is the crux of a bubble. Deteriorating asset quality creates balance sheet mismatches. Just as investors “reach for yield”, the first banks in on low quality loans show strong returns, so the whole banking sector joins in. Thus an imperfect indicator of declining asset quality is a high loans/total assets ratio. Vulnerability happens when loans season and NPLs creep up. Then banks need cash. When they don’t provision for losses you get a meltdown. China, Korea, and India have extremely low capital provisioning for this contingency. The Korean consumer sector looks shaky, although corporate balance sheets are much stronger and contribute to the high deposits to GDP in the first chart. A lot of Korean valuations are sky high and ready for a long drop. While the balance of loan growth, customer deposit growth, and capital to assets in India doesn’t look good, India is not as “financialized” to the same extent as the other countries. Because of this, it is less susceptible to deleveraging fire-sales and also rides a long term trend of financial system growth. Frankly, Indian risk started rolling over a while ago anyway. China deserves some attention. Flare-ups in Chinese social tension are a function of inflation. There are steps to it...

Now that the market is finally starting to digest the end of QE2 (if not yet pricing in the inevitable transition to QE3), investors are wondering where the most violent "regression to the mean" snapback will occur. And whereas many talk about the dispersion between equities and commodities and speculate about this and that compression trade, the truth is that within equities themselves there is far greater dispersion between one of 9 traditional equity sectors. To wit, as the first chart below demonstrates, since the Jackson Hole confirmation of QE2, energy stocks have outperformed utilities by an 4x order of magnitude. An almost as pronounced dispersion can be observed between financials and industrials/consumer discretionary stocks. For those who believe that the market still has to price in the end of quantitative easing part 2 (and ignore the inevitable roll out of QEx), a compression trade which involves a long Utilities/Fins and short Energy/Industrials/Consumer Discretionary would seem quite appropriate. There is however one caveat. If the market, in its traditional stupidity and irrationality, proceeds to go ahead an unwind not only the impact of QE2 but go all the way back to QE1, than the compression cohorts change drastically. While utilities are once again the worst performing sector since March 2009, and bested just barely by healthcare and consumer staples, financials are by and far the best peforming sector, having returned over 150% in the past 2 years, with consumer retail and industrials following behind. Thus, it probably makes sense to avoid any long Financial leg and focus purely on Utilities and Consumer Staples as the long led in a compression trade, while shorting Industrials and Consumer Discretionary, leaving Financials alone (John Paulson's projections of Bank of America hitting $30/share by the end of 2011 notwithstanding).

It was another manic Monday with lots to cover, setting the record straight on Bill Gross, China, and the commodity selloff...

Constitution toilet paper Indiana Supreme Court dispenses with Magna Carta, ConstitutionOn June 10, 1215 AD, after prolonged rebellion and frustrating negotiation, a group of England’s most influential barons entered London to force the disastrous King John Softsword into accepting a revolutionary charter of individual freedoms. Five days later in the Runnymede meadow of Surrey County, John affixed his royal seal onto what became known as the Magna Carta. It still exists on the books today in England and Wales. This document was one of the more important antecedents to the US Constitution; its proclamations ended the absolutism of England’s monarchy and spelled out very clear rights and freedoms, including, among others, the right of a man to enjoy his private property without trespass from government officials. Over 550 years later, the framers of the Constitution codified this right in the 4th Amendment to be secure in one’s private property. Last week, the Indiana Supreme Court effectively rejected both documents in two separate cases.

Below is a chart summarizing all the moves in the Paulson & Co. just released 13F. The total equity AUM increased to $34.6 billion, pushing the hedge fund further into mutual fund territory. The key addition in the fund was 25 million shares in Hewlett Packard, or roughly $1 billion, a position which is since at least 3% underwater. Other key additions included 17.3 million shares in Transocean (a 240% increase), which made the total stake worth nearly $2 billion and is now the 3rd largest Paulson holding, and make the fund the firm's largest holder: a move most likely predicated by expectations of an acquisition. Of course, RIG has been no stranger to the M&A/LBO arena, and should crude drop further, this could be another largely wrong way bet. Other major additions included a 6 million share stake in Lubrizol, and a $780 million new stake in Weyerhaeuser, in keeping with the fund's recent addition of paper stocks. In that vein, Paulson also added $353 million worth of Smurfit-Stone: a new position, and added 10 million shares to his holding of International Paper. Gold continues to be the fund's largest exposure: GLD, for the gold denominated share class (unchanged), and at number 2 Anglogold Ashanti, at $2 billion. Just like Tepper, Paulson reduced his holdings of Citi, Bank of America and SunTrust. The firm cut its entire holding of Alcoa, Pfizer, Del Monte, McAfee and Walter Energy.

Only The Bernank is fool enough to lend money to US at these rates but, then again, he's only lending us our own money so it's not like he himself is taking on any risk at all.

You all remember Nancy's terrifying fraudclosure break in 911 call, right? Well, they just did it AGAIN.

The economic peril that we find ourselves confronted with, has been ninety-eight years in the making. The confluence of debt, demographics, delusion, and denial has left the country at the precipice of annihilation. There are two kinds of people in the world, those who control the money and those that are controlled by those who control the money. The last century has been marked by a methodical looting of the good (working middle class) by the bad (Federal Reserve & bankers) and supported by the ugly (Washington D.C. politicians). When historians pinpoint the year in which the Great American Empire began its downward spiral they will conclude that year to be 1913. In this dark year for the Republic, slimy politicians, at the behest of the biggest bankers in the country, created a private central bank that has since controlled the currency of the United States. This same Congress staked their claim as the most damaging group of politicians in US history by passing the personal income tax in the same year. These two acts unleashed the two headed monster of inflation and taxation on the American people.

"The Justice Department is now contemplating whether to use the HUD audits as a basis for civil and criminal enforcement actions, the sources said. The False Claims Act allows the government to recover damages worth three times the actual harm plus additional penalties."

Equities have significantly underperformed credit the last two days but have plenty of room to go before they re-sync with any kind of value. Rotation under the surface points a risk-averse crowd seeking safety and not poised to BTFD.