Archive - Jun 2011 - Story

Before leaving New York, I was enjoying a perfectly nice afternoon yesterday walking around the Upper West side. When I got to Lincoln center, roughly at the corner of Broadway and W 62nd Street, reality set in. No fewer than ten NYPD storm troopers were ‘patrolling’ the sidewalk outside in full combat gear: Kevlar helmet, flak vest, semi-automatic 9mm sidearm, and Colt model 933 with M900 foregrip and M68 aimpoint. A few of them had M203 variety grenade launchers fitting snugly underneath the barrel. And to what did we owe the deployment of such unnecessary firepower? An invasion of the Canadian hordes? Terrorists on the loose? No. Some visiting politician… clearly an individual who feels important enough to merit an intimidating death squad in his vicinity. This is the nature of the system. Police are armed to the teeth… and while their official marketing slogan may be to ‘keep people safe’, their real function is to be the protectors and enforcers for the political class, all while keeping the people in check so that the know who’s boss.

Now that the Greek bailout is topic front and center for the second year
in a row, it means that it is time for the mainstream media to once
again prove to the world that in the past year it has learned precisely didley squat about
how the more complicated securities used in capital markets operate.
Such as CDS. Just like in May 2010, the prevalent trope among the clickbaiters
is that CDS written against Greece will destroy the world, in
superficial attempts to bring about panic induced by the faulty
conventional wisdom that CDS was the cause for the implosion of AIG.
Well, wrong.

Another revolution in China is impossible, you say? Please step this way into the time machine and return to 1979. The year is usually remembered for the Iranian Revolution, and many commentators are comparing the current "Arab Spring" revolts to the systemic changes unleashed in 1979. More interesting is the case of the Soviet Union in 1979, which appeared to all eyes as a permanent, stable political entity. The U.S.S.R. invaded Afghanistan on December 24, 1979, but that only seems noteworthy looking back from the present. At the time, there was still concern in the West that the U.S.S.R. would launch a blitzkrieg attack to conquer Western Europe. One-party systems lack the mechanisms for adaptation, and thus they are exquisitely ripe for revolution and implosion. Democracies and republics tend to have periods of low-amplitude instability (witness Greece right now) that enable the system to adapt and experiment ("fail fast, fail small" being the preferred process of adaptation). One-party systems, from the Liberal Democratic Party in Japan to the Communist Party in the U.S.S.R. and China, suppress the information and processes intrinsic to dissent, and thus build up intrinsically unstable systems...Both China and the U.S. may be quite different countries by 2021. It's worth recalling that nobody saw the 1989 implosion of the Soviet Union a mere ten years before in 1979, so it is not surprising no one sees the implosion of the Status Quo in China and the U.S. ten years hence.

Just in time for the end of QE2, when the US needs every possible foreign buyer of US debt to step up to the plate, we get confirmation that yet another major foreign central bank has decided to not only not add to its US debt holdings, but to actively sell US Treasurys. The WSJ reports that "Russia will likely continue lowering its U.S. debt holdings as Washington struggles to contain a budget deficit and bolster a tepid economic recovery, a top aide to President Dmitry Medvedev said Saturday. "The share of our portfolio in U.S. instruments has gone down and probably will go down further," said Arkady Dvorkovich, chief economic aide to the president, told Dow Jones in an interview on the sidelines of the St. Petersburg International Economic Forum." Well, with Russia out, at least we have China and Japan continuing to buy US debt.... Oh wait, China is contemplating dumping two thirds of its debt you say? And the biggest buyer of Japanese bonds is now in the process of selling Japanese bonds in the open market for the first time (so not really in the market of US bonds). Well, surely US households will step up to the plate. After all they all have so much "cash on the sidelines" courtesy of the Recovery^{TM ©®} that they can't wait to dump it all into paper yielding less than 3% a year, and has negative real rates of return. Wait, what's that: according to the Fed, in Q1 US "households" sold $1.1 trillion annualized in Treasurys to the Fed? So, let's get this straight: China, Japan, and now very much openly Russia, the three countries with the largest financial reserves in the world, are threatening, if not already dumping US bonds, just in time for US households to sell their holdings of US paper to Brian Sack. And this is happening 2 weeks before QE2 ends... Um... Are we and Bill Gross (and certainly not Morgan Stanley) the only ones to see a problem with this?

More on the latest confirmation that the time of US superpower supremacy has ended...

Below we present some additional analysis on the implementation of Dodd-Frank's precious metal and FX OTC spot trading prohibition from law firm Morgan Lewis, as well as another potentially far more disturbing implication for non-US Hedge Funds which trade FX (and since virtually all hedge funds are located offshore due to tax implications, and since most hedge funds have now shifted to FX trading in an attempt to pursue volatility, we imagine this means absolutely everyone in the space). Basically it appears that hedge funds that have "one single US investor [who] has less than $10 million in investable assets, that fund will be classified as a retail FX fund. If an FX fund has investors that fail to meet the $10 million threshold,
that fund would therefore not be considered an eligible contract
participant. Gary Alan DeWaal, senior managing director and group general counsel at prime brokerage firm Newedge, said most non-US FX hedge funds seemed unaware of these obscure, burdensome requirements. “Most hedge funds would not think that they are retail funds. However, all it takes is one US client, who fits into this bracket to make them a retail FX fund. I think a lot of hedge funds could be forced to either throw out these clients from their funds or change their counterparties,” added DeWaal." Forget the liquidity freeze courtesy of Greece. Our own congressional and senatorial idiots are about to do it on their own without any country having to go into default.

One small step toward Executive Order 6102 part 2, and one giant leap for corruptcongressmankind. "We wanted to make you aware of some upcoming changes to FOREX.com’s product offering. As a result of the Dodd-Frank Act enacted by US Congress, a new regulation prohibiting US residents from trading over the counter precious metals, including gold and silver, will go into effect on Friday, July 15, 2011. In conjunction with this new regulation, FOREX.com must discontinue metals trading for US residents on Friday, July 15, 2011 at the close of trading at 5pm ET. As a result, all open metals positions must be closed by July 15, 2011 at 5pm ET. We encourage you to wind down your trading activity in these products over the next month in anticipation of the new rule, as any open XAU or XAG positions that remain open prior to July 15, 2011 at approximately 5:00 pm ET will be automatically liquidated."

Everybody hates rating agencies. They missed Enron (balance sheet fraud), the sub-prime crisis (using models provided by banks) and sovereign debt crisis (concealed by foreign currency swaps). They have been wrong – so what? Stock market analysts are wrong all the time, and investors still read their worthless reports. And what would you expect from a stock recommendation if you knew it was paid for by the company the report is about? (People – you really need to switch off that Consumer News and Business Channel and put on your thinking caps.) Anyway. I came across this Weekly Market Outlook from Moody’s Analytics. They do something remarkable. They compare their own ratings with the rating implied by CDS (credit default swaps). Usually the rating agencies are a little bit behind the curve, so the CDS can give more of a “real-time” view of where the rating should be. Look at Bank of America and Merrill Lynch (now, of course, owned by BoA). Their implied rating is junk! JPMorgan Chase, Well Fargo and HSBC Finance Corp are not far behind in the BBB category.

Yesterday when we observed the conventional wisdom explanation that the CBOE equity put/call ratio is the highest it has been since January 2009 and hence the market must have bottomed, we naturally took the opposite stance, warning that any comparison to past events is necessarily apples to oranges, since the "last time we checked back in January 2009 Greece and Europe were not
about to go Chapter 11, nor was a $900 billion asset purchasing program
about to end." Well, we are not the only ones to ridicule yet another attempt by the media to sucker in the retail investor, who however following the biggest domestic mutual fund equity outflow since August is long gone. UBS' Andy Lees does a far more convincing job, and adds that "the skew to the downside is not reflective of
people being long puts but rather reflects the inability of funds to
carry any significant downside business risk. Putting these two bits of
information/ supposition together, clients are effectively running a
binary position where they can take the downside risk to a certain point
and then must get out no matter what which potentially means a gap down
or accelerated fall in the market, which would coincide with what the
charts are saying sub 1200. With the buyer of last resort, the Fed, no
longer there, the fall could become very nasty very quickly."   

Early this morning, Muddy Waters sent out the following email:

The Globe & Mail, one of Canada's largest newspapers, has published a lengthy investigative piece on Sino-Forest's holdings in Yunnan. The article corroborates Muddy Waters' research showing that TRE has massively overstated its Yunnan timber holdings.

http://www.theglobeandmail.com/globe-investor/key-partner-casts-doubt-on-sino-forest-claim/article2066110/

Muddy Waters is still short Sino-Forest.

Bottom line: a small 2-person operation outsmarted a $35 billion hedge fund courtesy of the first thing in a true investor's arsenal: real due diligence. The second and third things for those asking are, getting big enough where an economy of scale is all tha matters to any "investing" decision, and hubris. Next up: See No Forest halted indefinitely like most other Chinese fraudcaps, while John Paulson continues the denial farce, saying he is still "supportive." Unfortunately, we doubt his LPs will be, and with no "selectively created" CDOs available to offset the massive loss, and with Bank of America about to drop back to Paulson's cost basis in the mid $9s (which it will very soon once the liquidations prompt the firm to unwind the most liquid assets first), we wouldn't be surprised to see the unwind of the biggest hedge fund "success" story in recent history begin in earnest.

A New Hampshire man burned himself to death in front of a courthouse. The specific reasons are individual to him, regarding a domestic violence arrest and prosecution. But the larger reason he killed himself is that he says the system no longer follows the Rule of Law. Once you read past the details, he gives a fascinating analysis of the system. He argues for a complete takedown of the Federal Government and starting over from scratch. He may be an example of what is to come - people throwing themselves violently up against the system in order to bring it down. It's fifteen pages. Longer than Joe Stack's. But much shorter than the Obamacare bill.

My novel Hummel’s Cross takes place in pre-war (and wartime) Nazi Germany. In the course of writing the book I became fascinated by how a nation of such highly sophisticated and astute people as the Germans—who gave us Bach, Beethoven, Luther, Goethe, Schweitzer, Einstein, Handel, Nietzsche, Kant, Wagner, (and thrown in a few Austrians like Mozart. Strauss, and Haydn) etc. could be so easily led to their own destruction – taking much of the Western World with them – by a charismatic if empty man. I remember in the film Gladiator the observation is made that the Roman mob is fickle and easily led. Well, we have seen that in the case of this country in these times the mob is the intelligentsia in the media, the college campus, entertainment and some corners of high finance to name a few groups. In 2008, they looked to Barack Obama and like past societies feeling the need for guidance from on high projected upon him the their own needs, desires and (let’s be honest here) need to cleanse the sense of self-flagellating white guilt they continue to carry over a perceived racism in the country that is now more prevalent as a topic of media round-tables than it is a fact in day-to-day American life.

There is a kind of rubbernecking excitement that one experiences when we hear a person in position of power, control or money, utter something that is such a blatant lie that we wonder how anyone could believe listeners are so stupid to even remotely believe what is being said. The excitement is only magnified when we go back in time and re-listen the spoken lies, with the realization that they have already proven false. Perhaps nowehere in history is this kind of active revisionist history more appropriate then when listening to central bankers, who have been wrong on more occassions than anyone else in a professional occupation, and still retained their jobs. For everyone who enjoys being amused at the expense of others' stupidity, the latest note from Grant Williams will be full of delightful reminiscences. And while ridiculing idiots and institutional stupidity is easy, there is always a lesson to be learned from someone else's humiliation. Or not. Perhaps sometimes it is best just to jeer at the morons who are in charge of this wholo ponzi house of cards. As Williams says: "The trick is to try and figure out which words of encouragement being offered today by those doing the talking will be remembered for all the wrong reasons when viewed in the rear-view mirror of history. Fortunately, we have a collection of people at the helms of Central Banks, governments, political unions and international organizations who make this job fairly simple as most of what they all say will probably end up haunting them for the rest of their lives. All one has to do to steer through the turbulent waters is work out which comments from public officials are virtually guaranteed to be laughably off the mark, or which smack of far too much invested optimism, discount them in favour of logic and move forward."

It is Friday night, which means that any bad and self-discrediting news from Goldman Sachs are due any minute. Sure enough, the squid does not disappoint: "Following another dose of disappointing economic data, we have cut
our Q2 growth estimate to 2% (annualized) from 3%. We also have issued a
preliminary forecast for the manufacturing ISM in June of 52.0. At this
point, we still expect a bounceback in Q3 and beyond, but will need to
see significant improvement in the data over the next few weeks to
maintain that view." Zero Hedge's own ISM outlook is for a 48 print. And as we will comment on later, as JPM's Michael Feroli demonstrates, the fate of the economic pick up in Q3 is all up to car sales surging by about 58% on an annualized basis as predicted by IHS. Good luck with that. As we said yesterday, we expect Goldman to lower its H2 outlook to under 2% within a month, most likely following the next ISM miss and the disappointing NFP report due out in 2 weeks.

Last Friday, the CBOE Equity Put/Call Ratio reached the highest level in the past two and a half years, higher not only than May 2010 when the market plunged on the first Greek bankruptcy, but higher than March 2009 when the S&P hit 666, and lower only than the second week of January 2009. Additionally, while this one off event may be discounted, the 10 Day Moving Average, as shown on the chart below, has now lifted to levels not seen since February 2009. A quite note by Stone McCarthy captures the conventional wisdom on the topic: "Where a 1-day rise in this indicator alerts us to investors temporarily seeking protection against a market decline, an extreme high by the 10-day smoothing line reveals a more comprehensive sentiment buildup that typically proves to be a more reliable contrary indication of a meaningful bottom being NEAR." Perhaps. However, never in the past has the Put/Call ratio been at such levels even despite the multi-trillion backstop of central banks, and worse still, just two weeks in advance of when the Fed will end its daily stimulus program. The is a saying that being contrarian in the face of conventional wisdom is the only sure way to make money. The problem with that saying is that conventional wisdom is quite often actually correct. Furthermore, last time we checked back in January 2009 Greece and Europe were not about to go Chapter 11, nor was a $900 billion asset purchasing program about to end...

About the only thing that the doom and gloom crowd, the politicians, and the media all agree on is that credit derivatives are evil, unnecessary, ‘financial weapons of mass destruction’. With the European Sovereign Debt crisis escalating, the CDS market has once again become a topic of conversation. Many of the issues related to CDS that are discussed are old, misleading, or plain wrong. Here is my attempt to address some of the issues that come up most whenever CDS is mentioned: Credit Events; Exposures; Counterparty Risk, and Transparency. These are topics that need to be understood in order for investors to make informed decisions. I am not here to defend CDS as a product, but to try and shed light on the subject so that people don’t react to inaccuracies that cause them to make decisions based on incorrect information. Since so many journalists still feel that the investing public needs to see the boilerplate language ‘when yields go up, bonds prices, which move in the opposite direction, go up’ this may be an uphill struggle. But here is my attempt.