My June musings

Looking into my older posts (January and March 7) most of what I expected did happen.

We did see a small correction in the equity markets but no major correction. Using different indicators, it shows that equities are still too expensive. A correction to “normal” levels would be healthy. However certain forces do not want it to happen. The Plunge Protection Team was so far able to keep the US markets up and even push them higher. However anything kept artificially higher or lower will correct sometime in the future. For how more days/months or even years the markets can be kept up artificially can only be guessed. If the Plunge Protection Team keeps up being successful and the FED and Treasury providing them with all the needed liquidity this situation can be extended for quite some time. Back in 1998 equities were too expensive and several gurus warned of high prices and a possible correction. However the top was not until more than 2 years later (and possibly at that time with a lot less action of the Plunge Protection Team). The stocks I favored back in January, namely the Oil&Gas stocks have done fine this year. Unhedged Gold producers have not yet done as well as expected. Anyway it is a bit strange to hear that Barrick Gold, a producer with an enormous hedge book, should or already has been included in the HUI. That does not make sense at all.

Oil prices have gone up considerably this year (as expected). I still believe that we will see much higher prices over the next 5 years. Therefore investments in Oil should do well (check the Peak Oil blog from time to time for more information)

Gold/Silver has not yet shown the strength I have expected. In this case the Plunge Protection Team was very successful in keeping the prices down and under control. The situation does look negative and even top gold bugs are at least frustrated not to say negative. Well the market is clearly managed as can be seen with the price action which is not normal. Just look at the chart patterns that repeat basically on a daily basis. Why do Central Banks manage the Gold/Silver price? Gold and to a lesser extend Silver are the indirect indicators of inflation. Central Banks need to keep the gold price under control to make the market believe that inflation is not a problem. Anyway in order to go on with their FIAT money scheme people do need to believe in the paper money. As long as the Gold price can be kept low or at least be kept from rising too high too fast, the public will not show much interest in buying Gold. So for CB’s it is of up most importance to keep the Gold from rising. Again markets can be kept up or down artificially (in the case of precious metals it is down) but sooner or later the price will move to where it should be and that is in the case of Gold a price which is several times the today’s price. The situation today reminds me very much to the situation in June 2005, before the strong up move until May last year. I can feel the same negativism as nobody really wants to invest in the investment that apparently does not produce interest (who cares with the nice capital gains over the past 6 years). As a contrarian the actual situation is very much to my liking (of course I would love to see gold and silver prices much higher) but the extremely negative opinion is and has been positive in most cases in the past. Therefore I do expect a strong rally until the end of the year and I would not be surprised to see a price higher than USD 850 oz.

Soft commodity prices are volatile but on the move up. Using more and more of the grains to produce ethanol, demand of the grains will stay high. Grains are not only food for humans but as well for cattle. Therefore higher grain prices will lead to higher meat and dairy product prices. As a believer of Peak Oil (personally I believe that we passed Peak last year) and knowing that agricultural production, especially in the developed countries, is very energy intensive, I do not see how soft commodity prices could go down over the next years. I hope you have already experience in home grown food or have a place where you can grow your own food.

Industrial Metals. China and India will have to improve their infrastructure over the coming years. This will keep demand for industrial metals high. The trend of the urban population moving to the cities will not stop soon (unless forced by the authorities) and provided these people with basic services and infrastructure will need lots of the industrial metals. Yes prices have gone up considerably over the last years but demand is still high and physical stockpiles still low while production is not being increased.

Hedge Funds; well as expected (see my post from Jan and March) there are more and more hedge funds in deep problems. Somebody said “there is never just one cockroach. If you see one, you know there are more in the wall”. The only reason why there were still relatively few is due to pricing models (price to model instead of price to market). As long as there is no major sell action the funds still can use their price to model pricing. Once there would be a major sell action and positions could not be liquidated the prices in the market would fall down considerably and worse of all, the investments would be priced by the market. That means that the funds would not have any justification anymore to value the funds according to their models but would have to do it according to market prices. You can imagine that it is not in the interest of the funds and of those invested in the funds to see that these Hedge Funds will fall considerably in value. What happened recently? Some major holders of the CDO’s tried to sell (auction) part of their portfolio. Without success. The little they were able to sell was sold at prices far below what their models indicate (in some places there was talk of 20cents the Dollar). That shows that the market is absolutely illiquid and that nobody really wants that toxic waste. Furthermore it shows that if anything could be sold, market prices would be below the prices used in the pricing models of the fund. As hedge funds are leveraged to the top, the value of the portfolio valued at market would not cover the collateral needed for the credit positions. This would lead to further liquidation in order to fulfill the margin calls and so on. You can imagine, it is not in the interest of neither the Hedge Funds nor the banks to have this happen. Everybody would loose. Furthermore those who granted credits do have big positions of the same investments on their books as well. The exercise of liquidation of the Bear Stearns fund was stopped. Bear Stearns was forced to extend a USD 3, 2 billion in more loans to its hedge funds. They did buy some time. Will they survive? We will know in due time. Anyway the risk for chain reaction still exists. There are undoubtedly a large number of other hedge funds with portfolios similar to those of Bear Stearns. So any major auction would really expose the true price these holdings. So having some more time to the day of reckoning is good news for all these hedge funds.

Housing: Real estate prices in the US are definitely not going up. Foreclosures are going up dramatically (including affluent areas). To get excellent information about real estate please visit the webpage with excellent information. Just one comment from my side, I do not believe that we are far away from the bottom and it does surprise me enormously that any entities related to the sector, such as Fannie Mae and so on, are going up in prices. Can really someone believe that there is a bigger fool out there willing to pay a higher price? Or as with other investments as well, is the market managed. Of course that could very well be the case.

Derivatives. My worries are still the same. More and more derivatives are used. This casino is another bubble to burst sometime in the future. There are so many derivatives and structures that possibly nobody really knows what risk they have in their books. Needless to say that they can not have the slightest idea of their real counterparty risk. Hope the Domino will not fall soon.

Fixed Income. Well it seems that some Central Banks started to sell. Rumors are that China or a government agency of the Chinese party was the seller. Was it to show what they could do? Was the message “careful, we do not like you to tell us what we should do, especially when the problems are in fact on your side”. Well there are not many CB’s buying Treasuries anymore. The only CB is the one that wants to keep yields low and possibly is buying there own debt (printing money). Well with almost no demand there is only much room for higher yields and not so much lower yields.