Archive - Jun 2011

I love Exchange Traded Funds (ETF). In theory. In practice they are being abused by issuers and traders alike (see Beware of systemic risk in ETF). But that’s another topic. Today let’s take a look what can happen with inverse ETF through the compounding effect. I like inverse ETF (i.e. SH) on the stock market, because if I am wrong (market goes up), my problem gets smaller (ETF goes down). If I had sold short the market (i.e. SPY or via futures) my problem would get bigger. Of course this “advantage” comes at a certain cost in form of a potential performance drag. To make it clear, let’s look at 4 simple examples...

Pimco has just released its May Total Return Fund holdings data, and we are delighted to discover that following all the recent debate over whether PIMCO is or is not short Treasurys, the firm has relented and has actually changed the way it reports it exposure, which in turn is precisely just as we had speculated: a modest long cash position offset by a substantially larger swap short. Yet combining the three (the firm now breaks out its "Government Related" category into Government- Treasury, Government- Agency and Swaps and Liquid Rates, which had been lumped before), we find that on a Market Value basis PIMCO is still short government securities to the tune of -3%, a minimal increase in its exposure from April when this was -4%. Yet on a duration weighted exposure basis, the firm's Swaps and Liquid Rates, the flagship fund's positioning is a whopping -31! Just as importantly, semantics aside, TRF's net cash position declined from 37% of its $243.2 billion in AUM to...35%, or $85 billion in cash. Hardly much of a vote of confidence in US government paper.

Behold...

Yesterday, just after 8 pm Eastern we presented a very curious move in NatGas trading on the NYMEX when under very light volume, the NG performed something akin to a sine wave expansion, with about 12 peaks and troughs with ever increasing amplitude, until ultimately it triggered a major sell off when it appeared to touch off an avalanche of limit orders about 3% from the prevailing price, leading to an almost instantaneous 8% drop in Natgas which was promptly recovered. We dubbed this a fractal pattern, and after a follow up with the trade forensics experts at Nanex, it appears this was a very spot on designation, as zooming into the pattern indicates increasing levels of self-similarity and complexity. Yet aesthetic observations aside, this latest algo appears to be nothing more than a limit order-busting market manipulation device, whose sole purpose is to destabilize and generate volatility for the creator of the algo. Curiously, as Nanex indicates, the algo is not limited to Natgas but also appears to recur in other far more liquid instruments, such as the SPY, when a comparable fractal pattern was observed in broad daylight. As to how the algo itself profits from the price instability it generates: we are unsure. One could certainly trade the increased volatility through derivatives, by buying vol cheap in advance of such as limit order triggered waterfall, especially in very thin markets, and then selling the vol at the apex of a given move. Obviously, this is merely speculation. That said, we are dead certain Finra and the SEC are promptly pursuing the trader responsible for this glaring attempt at market manipulation in order to find out precisely how one profits from such fractal algorithms.

"The primary trend I see in the markets is the destruction of the purchasing power of all fiat currencies, with the U.S. dollar having the most to lose as the world’s reserve currency. Nothing throws a population into more of a tizzy than a destroyed currency. Similarly, nothing provides a more fertile ground for power hungry control freaks to take over your lives than economic chaos. What has really started getting my attention in the last several months is how the UN seems to be trying to position itself as a “world government” savior of sorts. First, the UN decided it would be a good idea to launch a war in Libya and Obama decided the U.S. would get involved without ever asking Congress for an authorization of force (which according to George Friedman of Stratfor is a first). What is so pathetic is where are the fake liberals in America? Where are the anti-war protests? We are so successfully divided in the fake Republican/Democrat, Red/Blue, Yankees/Mets paradigm of stupidity that the “left” in this country won’t criticize Obama for starting a new war because he is “their guy.” This is pathetic and dangerous because guess what will happen when we get a Republican thug as president that uses the precedents Obama has set to shed even more blood all over the world. Who will protest then and who will care? "

We have complete the cursory first run of the just released quarterly Flow of Funds (Z.1) updated for Q1 2011. While we will present the far more important breakdown of the shadow economy, we first focused on the key asset and liability data covering the household, corporate and government sectors, which presented few surprises. In summary, total household net worth increased by $1 trillion from $57.1 trillion to $58.1 trillion in the 3 months ended March 31, 2011. This the highest level of household net worth since Q2 2008 when it stood at $60 trillion, and still down substantially from the all time high of $65.7 trillion in the summary of 2007, or the peak of the credit bubble. Looking at the asset components we see once again just why Bernanke is so focused on pumping up the Russell 2000: the stock market (through holdings of corporate equities, mutual fund shares, and pension fund reserves), accounted for $1.2 trillion of the $1.0 trillion increase. This paper profit was offset by a $349 billion drop in mortgage equity, which declined to $18.1 trillion, the lowest in almost a decade. Additionally, household deposits increased to the peak level of $8 trillion once again, which is explainable since household liabilities declined with a drop in both mortgage ($68 billion) and consumer ($31 billion) debt. In a nutshell the consumer continues to delever. But probably the most surprising move was the substantial drop in the positive contribution to total debt from state and government debt. Coming in at $9.6 trillion, total government debt outstanding, rose by the lowest amount since Q2 of 2008, courtesy of a modest increase in Federal Government debt of $184 billion and an actual decline in state and local government debt of $18 billion.

Today's $13 billion in 30 Year bonds (Cusip QQ4) priced at a disappointing 4.238%, with a nearly 4 basis point tail to the when issued which was trading at 4.19%, which resulted in spooking the bond market briefly and causing some LT curve jitters. The Bid To Cover was 2.63, a bounce from the May 2.43, though below the LTM average of 2.68. The internals were relatively normal: Indirects taking down a below average 38.4%, Directs purchasing 9.3% of the auction, and Dealers left holding the bag, even if only for 2 weeks, with 52.3% of the auction. The Indirect bidder hit rate raised a few red flags coming in at a rather high 77.3%, although besides the surprisingly big tail, the auction once again came in as expected, which is to be expected: after all dealers will flip the bulk of it back to the Fed at the next two 17-30 year POMO.

A snapshot of the US Afternoon Briefing covering Stocks, Bonds, FX, etc.

Market Recaps to help improve your Trading and Global knowledge
Weakness in CAD evident after mixed Canadian economic data

On the rare occasion that I’m bored, I like to watch 24-hour news television for entertainment. It’s hilarious watching the talking heads spin out of control in apoplectic fits when they’re essentially arguing the same point; they might be from different parties, but they’re merely battling over small details of the same government-sponsored solution. Recently I caught one of these talking head financial experts on TV arguing about debt levels in the United States. He was saying that the US debt doesn’t matter all that much because the US government has so many assets to offset its debt. For example, he suggested that things like the highway system, national parks, and strategic petroleum reserve would more than offset America’s liabilities, so the looming national debt isn’t such a big deal after all. He couldn’t have been more wrong.

Just like last year when the first bailout of Greece was met with significant opposition by German constitutional professors, the constitutionality of the upcoming bailout #2 is about to be questioned. Only this time it does not come from powerless academic but from the very top: the Federal Constitutional Court. From Frankfurter Allgemeine (google translated): "The federal government has to explain how the measures are compatible with the Basic Law....The government will have to justify before the court how the measures conform to the stabilization of the European currency with the Basic Law, and possibly with European law. It was originally envisaged in the Second Senate to negotiate in private. But this stance has apparently changed in the course of the discussions." As expected, the fine legal print is once again about to throw a major monkey wrench in the ongoing usurpation of constitutional right by the banking syndicate.

Post Includes Police State Search Warrant on Student Loan “Default”

For those who care what is happening behind the scenes even as everyone continues to predict there will be no snags associated with the transition from a QE2 to a non-QE2 world, should look at this brief analysis. On May 26 the Treasury issued $29 billion in 7 Year bonds (Cusip QQ6)- the auction was considered a smashing success by all with the Bid To Cover coming at a record high 3.24 Bid To Cover, and pricing 2 bps inside of the When Issued: an indication of massive demand. Dealers were allocated $11.4 billion and as Stone McCarthy reported: "The $62.3 billion Dealer bid was up from $54.7 billion last month and it was the largest Dealer bid since February 2010." So far so good right? Here is what happened next. On June 1, barely a day after the bonds had settled, Dealers shipped $5.393 billion right back to the Fed (making who knows how much in "fees" in the process) in that day's POMO. And today, just a week after the last 7 year targeting POMO, Dealers sold another $3.168 billion to Brian Sack. Total tally: $8.561 billion monetized by the New York Fed in less than two weeks following the auction. Simply stated: the Dealers' unprecedented interest  in the auction... was transitory. Just two weeks later, the Dealers have flipped back 75% of their entire position in the latest 7 Year On The Run bond. And this is the kind of sleight of hand that allows the Treasury to represent success after success in bond auctions, only to allow the Fed to do the backdoor switcheroo literally hours later, and compensate the conning Dealers for fooling the marks: in this case US taxpayers, naive believers that there is actual interest in US Paper, and of course China and other foreign investors who bought $13.8 billion of the same auction. What happens when Dealers are unable to flip up to 75% of any given bond back to the Fed in under two weeks: stay tuned and find out in precisely 3 weeks.

Just when one thought every imaginable taxpayer bailout scheme had been seen, experienced and in many cases, forgotten, here comes AIG once again. The specifics come from Deutsche Bank's Joshua Shanker initiation of coverage report on AIG (naturally with a Buy rating, $34.00 target price), where within the fine print he notes: "the company believes there may be bargains available from buying RMBS securities from European banks seeking better positioning under Basel III requirements. " Prudently, he adds: "We note that increased yield, in this regard, also carries with it increased risk." Translated this means that AIG is about to do for European banks what the ECB so far has been unwilling and/or unable: namely to transfer the risk associated with European banks' massive ongoing exposure to the continuously collapsing US housing market back to the US taxpayer, in the form of AIG, which was bailed out once, and which will certainly be bailed out again, when the time comes.

So much for transitory inflation as corn prices are again pennies of a fresh all time high. Earlier today an update by the USDA showed that corn stocks will come in much lower than expected at the end of the 2011/12 marketing year at just 695 million bushels: this is far lower than the analysts consensus of 771 million bushels. The spring weather was blamed for the drop: "cold, rainy spring and flooding cut U.S. corn plantings by 1.6 percent, will reduce the harvest by 2 percent and will keep U.S. corn supplies at their tightest level in 15 years through the fall of 2012, the government said on Thursday." Another factor for the record price: surging China demand: "USDA also forecast a hefty increase in corn use by China -- up 8 million tonnes, or 5 percent, this year and up 13 million tonnes, or 8 percent, in 2011/12. China will draw down its stocks rather than import corn, USDA said." Just like in China where record droughts have been replaced with deadly floods, the weather continues to be unusually volatile, not just in the US: "Besides plaguing the eastern Corn Belt, rains and
floods have slashed the rice crop by 5.5 percent since May, USDA said.
Drought in the Southwest would reduce the cotton crop by 1 million
bales, or nearly 6 percent, to 17 million bales, and the rice crop, at
199.5 million hundredweight, would be the smallest in four years." This is probably the latest data the market needed to completely ignore today's worse than expected initial claims data, and go into full "Inflation: ON" mode. In other news, expect Obama to announce the launch of an Adverse Weather Task Force investigating speculative movements in air masses momentarily.

So our Federal Reserve Chairman, with a supposedly Mensa level IQ, declares that prices have risen due to demand from emerging markets. He also declares that US economic growth will pick up in the 2nd half of this year. He then declares that inflation will only prove transitory as energy and food prices will stop rising. I know I’m not a Princeton economics professor, but if US demand increases due to a recovering economy, along with continued high demand in emerging markets, wouldn’t the demand curve for oil and commodities move to the right, resulting in even higher prices? Ben Bernanke wants it both ways. He is trapped in a web of his own making and he will lie, obfuscate, hold press conferences, write editorials, seek interviews on 60 Minutes, and sacrifice the US dollar in order to prove that his economic theories are sound. They are not sound. They are reckless, crazy, and will eventually destroy the US economic system. You cannot solve a crisis caused by excessive debt by creating twice as much debt. The man must be judged by his words, actions and results.