Archive - Jul 27, 2010 - Story

For those looking at the recent moves in the gold chart with disenchanted amusement, here are some scenarios to ponder. Below are the recent cycles associated with the S&P priced in gold (ratio format), where it is can be seen that the ratio is once again climbing to the upside, just below 0.96. That's fine, although as the chart demonstrates the lower low moves occur with greater frequency and greater downward momentum with each iteration. Yet where this chart gets interesting is when it is recreated from the perspective of the 1930s. As can be seen, the recent lows in the ratio at around 0.9 are a joke compared to the nearly 0.2 achieved in 1932... just before FDR decided to make gold ownership illegal.

In our day and age, when implied correlation is approaching 1 with each passing day, and when nuanced relationships are ignored, as every correlation somehow immediately becomes causation only to be invalidated, chewed out and left for dead, there is one certain and virtually guaranteed statistical relationship left, that not only persists day after day but has now become its own self-fulfilling prophecy. We speak of course of the (inverse) correlation between stock prices and volume: i.e., "volume up, stocks down; volume down, stocks up." Rinse, repeat, over and over and over. Rarely has this correlation been as pronounced (although we have been discussing it for well over a year) as over the past 12 weeks. Behold.

One of the odder stories of the day comes from Dow Jones, which reports that the Chinese Sovereign Wealth Fund (China Investment Corp, or CIC), has sold $138.5 million worth of Morgan Stanley shares in the past week, after dumping 4.53 million shares at $27.17 on Wednesday and 575,000 shares at $27.13 on Thursday. CIC began accumulating a massive Morgan Stanley stake in 2007, when it purchased its initial shares in the then troubled investment bank, and followed up with a June 2009 $1.2 billion investment, The reason for the sale, DJ speculates, is for the fund to avoid "additional disclosure requirements." Yet as a filing as recently as June 18 disclosed, the fund's Morgan Stanley stake was openly disclosed to be 11.64%. Surely the CIC administrator, the PM and everyone else in the front and back office were all too aware of this number. Which is odd since per both initial and follow up purchase agreements, CIC had stated it would not own more than 9.9% of MS' shares, and would remain a passive investor. That the firm would blatantly purchase 16% more than this threshold in the open market by mistake in the past year seems somewhat ludicrous. Worth recalling is that in June CIC disclosed a 10% MTM loss for the month of May, or roughly about the time it announced its above normal MS exposure. Are the two related? Has the CIC been covertly liquidating assets? It is unclear, as the one and only 13F for CIC is still the original one filed from February (covered here). One would imagine there would be at least some SEC requirement that a filer that has issued at least one 13F would be so kind to follow it up with at least a second one... eventually. In the meantime there is no official statement on the transaction: "A spokeswoman for CIC said she was unaware of the reason for the sales. A Beijing-based Morgan Stanley spokeswoman declined comment."

RANsquawk Market Wrap Up - Stocks, Bonds, FX etc. – 27/07/10

A few days ago FOFOA drew quite a bit of attention with his post "Red Alert: Gold Backwardation", in which the topic of the GOFO rate receives prominent attention (GOFO is basically the difference between a currency lease rate, in this case dollar Libor, and the GLR, or the Gold Lease Rate, as per the LBMA). FOFOA draws several correlation between the GOFO and an implied backwardation, and asks the question: “Is the dollar bidding for gold, or maybe gold is bidding for dollars?” Indeed, while one read of the underlying material does substantiate the presented hypothesis, another is merely that there has been too much turbulence in the currency market, with Libor, not just USD, but especially EUR, surging recently, on very valid liquidity concerns out of Europe. As a result of the massive squeeze first in the dollar and then in euros, a topic much discussed here previously, one could reach a point where the GOFO is in fact negative, merely due to vol in interbank and money market, which in turn is driven by ever faster liquidations in the shadow banking system, another topic much discussed on Zero Hedge. Certainly, when both of these are in flux, it would be expected that GLR would also do some very peculiar things. Either way, FOFOA has conceived an interesting theory, and gold fans will appreciate the thought experiment of gold being in backwardation. We present Professor Antal Fekete's response to FOFOA's analysis. Both are an interesting read. (The FOFOA post can be found here).

With everyone now agreeing fundamentals are completely irrelevant, the only things that could possibly matter are charts. And in this particular case, the key one on an ultrashort term momentum-driven basis likely is the ES upchannel as seen on the chart attached. Every time the support barrier is approached, a few hundred blocks appear our of the woodwork to preserve the self-fulfilling fantasy. Yet, it is getting increasingly more difficult to validate the phantom buying. Keep an eye out on this channel in the next few hours/days.

Last Friday we reported that the most important (and most underreported) story of the week was Bloomberg's disclosure that Chinese banks may struggle to recoup about 23 percent of the 7.7 trillion yuan ($1.1 trillion) they’ve lent to finance local government infrastructure projects, and that only 27 percent of the loans to the financing vehicles can be repaid in full by cash generated by the projects they funded. As this is a topic that deserves much more attention, we present the views of Goldman's Ning Ma on this critical issue, which when combined with Fitch's recent disclosure that the CDO market is ramping up in full force halfway across the world, and that China has 66 million vacant homes, should all come together in a nice and tidy confluent package of a combustible real estate-cum-credit explosion. Of course, this being Goldman, guess which way the spin is pointed: "We continue to believe systemic risks associated with such loans are limited. Key to watch: The results of restructuring and NPL recognition in 2H10 (mainly from unrecognized social projects and misused loans, but likely far less than 23% NPL ratios), and credit cost allocation among banks and local gov’ts." In other words, ignore the biased conclusion, but certainly focus on this most recent unravelling of the Chinese bubble.

Even as stocks continue pricing in QE2 (presumably some time in the next 2 years), bonds keep on laughing. The $38 billion in 2 Year Bonds just auctioned off at a 0.665% high yield, the lowest yield for a 2 Year primary issue. The bid to cover came in at 3.33, compared to 3.45 previously, and 3.15 average. Indirect participation plunged to 32.8%,compared to 41.41% previously. As the directs took down "just" 13.5%, the Primary Dealers ended up taking down a majority of the $38 billion bond auction, or 53.7%. The recycling of cheap Fed money has now fully arrived, and with an Discount Window to 2 year arb of 0.4% (0.66% - 0.25%), it shows just how bad things must be for the PDs.

Ever wonder why according to the latest economic poll published by Reuters earlier the general public's satisfaction with Obama's handling of the economy is deteriorating faster than any other issue? (not to mention that 46% of Americans believe Obama is not focused enough on job creation, and that 72% of republicans say they are certain to vote at the November congressional elections versus 49% of democrats). A part of the answer comes courtesy of a new study produced by National League of
Cities, the U.S. Conference of Mayors and the National
Association of Counties titled simply enough: "Local Governments Cutting Jobs and Services: Job losses projected to approach 500,000", showed local governments moved to cut
the equivalent of 8.6 percent of their workforces from 2009 to
2011. As a result of local government cutbacks, almost 500,000 people will lose their jobs, and the total will likely rise. The summary of the report attached below, is particularly grim: "Over the next two years, local tax bases will likely suffer from depressed property values, hard-hit household incomes and declining consumer spending. Further, reported state budget shortfalls for 2010 to 2012 exceeding $400 billion will pose a significant threat to funding for local government programs. In this current climate of fiscal distress, local governments are forced to eliminate both jobs and services." If Americans are dissatisfied with Obama's handling of the economy now, just until 2012.

RANsquawk US Afternoon Briefing - Stocks, Bonds, FX etc. – 27/07/10

The age old debate of whether luck or skill is more important for an investors'a success will likely never be resolved, although the attached presentation by Legg Mason's Michael Mauboussin provides some colorful anecdotes to validate the view of either side of the polemic. To be sure, working with someone like Bill Miller, Michael must be all too aware of just how prominent a role luck plays (or at least decade long leveraging into a cheap market bull run, only to see all your profits and reputation evaporate overnight when it all comes crashing down), which is precisely why his conclusion tends to veer on the side of skill. Obviously, when dealing with such concepts that have Gaussian distributions, as stocks increasingly demonstrate fractal features (courtesy of HFT), the whole debate is becoming increasingly moot. Yet Mauboussin does have an interesting discussion on reversion to the mean phenomena: something which in a world of near 1.000 implied correlation is of huge and often underestimated, significance: "We have mentioned already that reversion to the mean ensnares a lot of decision makers. This is
so important for investors, however, that it bears additional comment. The sad fact is that there is significant evidence that investors—both individual and institutional—fail to recognize and reflect reversion to the mean in their decisions. To illustrate, the S&P 500 Index generated  returns of 8.2 percent in the twenty years ended 2009. The average mutual fund saw returns of about 7 percent, reflecting the performance drag of fees. But the average investor earned a return of less than 6 percent, about two-thirds of the market’s return. The reason investors did worse than the average fund is bad timing: they put money in when markets (or funds) were doing well and pulled money out when markets (or funds) were doing poorly. This is the opposite of the behavior you would expect from investors who understand reversion to the mean." Ironically, investors have learned their lessons: after a nearly 60% ramp from the all time lows, investors continue to refuse to buy when everyone else is buying, contrary to the pleading by Obama, and all the conflicted fly by night permabullish mutual fund managers which CNBC appears to have an infinite collection of to recycle and fill content inbetween all those incontinence ads 24/7.

For the few, the proud, the stuck in the 19th century, with an "originate to hold" business model (such an anachronism when originate to distribute by hedge funds, pardon, banks is all the rage), the latest data by Freddie Mac, in which the 30 Year Fixed just dropped to a new fresh all time low of 4.56%, down 1 bp from the last two weeks, is about the worst news possible. While the short end is still cheap (and in the case of 2 Year, near record), the ongoing flattening is a death knell for anyone who still relies on funding curves to a some profit. As the Bloomberg article pointed out earlier today, the 60 bp tightening in the 2s10s is a huge impact to P&Ls, which is now actively reverting profits afforded to financial companies in 2009 and early 2010. Soon enough, the Fed's active management of the yield curve will force banks to come up with new and improved ways to pinch pennies from US consumers now that the profitability margin on the curve has been cut by 25% in a couple of months. Alas, that would mean the risk of inflation would have to be taken seriously. In its absence, look for flattening to continue as all on the wrong side of the trade continue capitulating, and making the future for JPM, Wells and BofA uglier by the day.

Rosie's market commentary from today is quite colorful, taking on both Barton Biggs (why bother) and Richard Russell as inflection point contrarians (we fully expect Barton Biggs who has now generated enough commissions for his broker to kill his entire P&L for the decade, to go bearish in about two weeks in keeping with his latest standing wave oscillation from one extreme to another). Rosie discusses a topic near and dear, namely that bonds continue to not buy the equity rally, and that the market is really not only stupid and inefficient, but wrong and overshooting most of the time. The only question is for how long can it remain wrong. And courtesy of the Fed, the answer is long, long, long. Not surprisingly David ridicules the constant lack of volume to the upside, and concludes that the rally should be faded, and that "this market is completely unprepared for 500k claims and sub-50 ISM." Obviously, he expects both to occur shortly (and just in time for Shiller to say he believe the chance of a double dip is more than 50%).

Major plunge in Consumer Confidence, which came at 50.4, below expectations of 51.0, and down almost 10% from an upward revised prior 54.3 reading, previously seen at 52.9: yes lower, but this BS revision was enough to make the jump in new home sales appear amazing post revision. Let's see if a real plunge in consumer confidence is enough to take the market lower by 100 DJIA points. Something tells us the gaps on revised data are only to the upside.

Expect absolutely nothing to happen today, with the possible exception of a counter trend move higher due to residual pull from the August 1200 strike. That said, lots of interest in the 1150 put already today.