update oct.27

Credits
CDOs shutting off payments - NY TimesCiting analysts and industry executives, the Times reports that collateralized debt obligations are starting to shut off interest payments to investors in riskier bonds as the credit rating firms downgrade the securities they own. The paper adds that the removal of this cash flow, which is mandated by quantitative formulas that vary by security, is expected to accelerate in the coming months, potentially forcing the investment banks, hedge funds, insurance companies and public pension funds that own the securities to take further write downs on subprime-mortgage debt. According to the Times, some bonds have seen their valuations decline from 70 cents on the dollar to essentially worthless overnight. The article goes on to note that Merrill Lynch,which wrote down $4.5B in mortgage-related debt in Q3, was far and away the largest issuer of collateralized debt obligations, underwriting $54B last year. The above NY Times article is from the beginning of the past week. In fact it came worse than that. According to AP on Wed. 24th, Merrill Lynch & Co., the world's biggest brokerage, on Wednesday said the summer's credit crisis triggered a bigger-than-expected $7.9 billion writedown during the third quarter. http://news.yahoo.com/s/ap/20071024/ap_on_bi_ge/earns_merrill_lynch_8;_ylt=Akmt1TYME2KaQj9_20KrV1kE1vAI
This amount is substantially higher than what NY Times reported. My guess is, that we will hear a lot more about writedowns in the coming months, especially with banks having astonishing high amounts booked under level 3.



FED
Markets kept well (congratulation to the PPT). As long as markets keep up well there is no reason for the FED to lower rates. In case the FED would reduce rates this coming week, it would show that they are really scared about the economic, credit and possibly derivative situation.


From the Grandich letter
In August 1987 Peter Grandich wrote about the expectations of a market crash within weeks. At this time he was Head of Investment Strategy for a NYSE Member firm. According to his newsletter from this month he was called by his boss when he forcasted the market correction back in 1987. His boss urged him to retract the forecast and when asked why the boss gave the following answer:
Quote
Peter, 90% of our clients will never sell all their stocks as you suggest. They will look to keep some, if not most. If you end up wrong, and I believe you will be, they will laugh at you and never listen to you again because you would have cost them their gains. If you end up right, they will be in no position to take advantage when you decide it’s time to buy stocks again.”
“Now let’s look at the 10% who may listen to you. I’ll bet half of them will be too scared to jump back in when you tell them, leaving only 5% of all our clients benefiting from you advice. Peter no firm on Wall Street can survive with only 5% of our clients profiting from our advice”
Unquote
Well now you may understand why bankers normally to not recommend to invest in precious metals or commodities. Unless you are a frequent commodity future trader there is not much money to be made by the Wall Street firms on clients who especially are invested in precious metals.
Grandich is right now very negative for the markets. If you are interested in his opinion, read his Oct.14 Newsletter on the following link
http://www.grandich.com/docs/alert_10-14-07.pdf



Gold
Found on a Swiss Postcard
“In Gold we Trust”, old Swiss Philosophy
First day after the G7 meeting and Gold price was bashed down. This definitely smells like intervention. The world has taken knowledge that the situation, especially in the US and as well worldwide with the over leveraged and risky investments is not looking well. To me it seems that international investors take a lower USD as a given. This is the real reason why the gold price has been going up over the last months. Of course Central Banks have to keep the Gold and Oil price under control. Therefore more interventions on Gold and Oil can be expected. However any intervention will only have a short term negative impact and in fact does open opportunities for all investors who like to buy gold at lower prices. This correction on Monday was in my opinion healthy and the price increase up to USD 783 confirms this. My personal target for this year or early next year is still USD 950 per ounce.
Gold and China: China might import more gold over the coming months:
Sources familiar with the gold industry predict imports to China to rise, according to today's China Business News. Zhang Weixing, an industry expert said gold in the Chinese market will be scarce next year due to investment and collection fever. "It is possible more gold will be imported from overseas," he said.
He made the remarks in an investment forum held in Beijing on October 20. Zhang predicted the general civil gold reserve has reached 4,000 tons, while reserves at People's Bank of China total about 600 tons.
"Average gold consumption in China is still much lower than international levels, although consumption has increased from 0.16 grams in 2002 to the current 0.35 grams," said Zhang.
Zhang said the price of gold has been pushed higher by a weakened US dollar, geopolitical concerns, and record high price. In China, more people are shifting to buying gold products on news of rising CPI and stock fever.
Huang Hanju, president of Xihanzhi Gold Co Ltd, said the rising gold price provides a stable investment channel for ordinary people.
The price of gold has leaped to its highest level since 1980, surging to as high as US$771.10 an ounce in trading.
The precious metal has now risen by almost 30 percent in value over the last year. The price in 2002 was around US$300.
Gold and Manipulation of Gold price: please read
http://www.gata.org/node/5654



USD
Like with Gold we should see some interventions in order to support the USD against other currencies. That means that we might see a bear market rally of something between 5 to 10% over the next weeks. However I expect the USD bear market trend to go on for some more time because I do not see yet how the confidence in the USD has come back. Therefore I believe we will see a much lower USD over the coming months.
Jim Rogers Shifts Assets Out of Dollar to Buy Yuan http://www.bloomberg.com/apps/news?pid=20601087&sid=amQBwDBSDvBE&refer=worldwide

In August, the central banks of Japan, China and Taiwan sold U.S. Treasuries at the fastest rate in as many as seven years.
Taiwan cut nearly 9% of its Treasury holdings, its biggest sell-off since 2000. China shed more than 2%, their biggest move since 2002. And Japan dumped 4% of their U.S. Treasures… their largest reduction since 2002

Oil
Well geopolitical tensions helped the crude to reach new highs this week. Unless these geopolitical tensions increase more I still believe that Oil prices have gone up to fast and that a technical corrections is possible. However the correction depends on how high the prices will go. For the moment being I still believe that a price of USD 75 over the next weeks is possible.

Peak Oil (The information about Peak Oil is not really information that is to our liking. Therefore if you get depressed easily, please just switch to the next topic)

Below you find a chart with the calculation of experts from ASPO


According to above chart, peak is in 2008. Please take note that not only all world regions have been taken into account but as well heavy crude, deepwater and so on.

This is the story of discoveries. Unless there will not be any significant discoveries we will feel it fast. As you might now, I am of the opinion that we passed peak last year in 2006.



Peak Oil will lead into Peak Food. Expect Food prices to go up much much higher in the coming years. Once again if you are owner of arable land, congratulations, you will do better than many others. If you are not owner of arable land it might be a good idea to look for some piece of land or to start growing your own food in your garden to have an idea about food production read the following article from 2003 http://www.organicconsumers.org/corp/fossil-fuels.cfm (read only if you get not depressed easily) for the Spanish version http://www.crisisenergetica.org/staticpages/index.php?page=20040706185428361
For updates on Peak Oil related news, check from time to time
http://themusingsoffritz-peakoil.blogspot.com/

Oil and possible geopolitical issues. Although the information is fiction and funny to read, it shows us what could happen when… http://www.newcolonist.com/dim_ages.html



Marc Faber Says Fed `Like a Bartender' Cutting Rates
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=amQ0s5S8e7.Y
Marc Faber with some interesting information.
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=ah1k1HqWbcFU


Baby boomers
In my last post I mentioned the first official Baby Boomer retiring in January next year. I mentioned as well that these Baby Boomer will sell stocks out of their 401K on a monthly basis in case they still will be able to do so. Last week I found the following article which shows that the 401K are already looted now. http://www.chicagotribune.com/business/yourmoney/chi-ym-borrowing-1014oct14,0,5181066.story.

PPT and Manipulation
Information from le metropole cafe:
Listening to Bloomberg Tom Keene was interviewing Arthur Levitt, former SEC chairman, regarding "lessons from 1987". Very interesting words from and insider. Particularly interesting is were his comments about Paulson, and how Paulson is "pro- active" end especially his comments about "jawboning" as an effective measure were fascinating:He says:”The treasury secretary (Paulson) will call market participants and make suggestions as to what should be done; .... these suggestions in general were accepted in a way an order would be issued, and it would be acted upon!......" Tom Keene is quite astute to press him on that point and asked him to more clearly define "jawboning" (around 11:45-
A quote:
"It calls for knowing the right people, the powerful people who can make decisions and make a difference and persuading them that it is in their interest to do this and do it promptly! There is sufficient power behind the secretary of the treasury or the chairman of SEC or the heads of any of the other agencies that that call is tantamount to a command." .... (13:35 ...ff)It is striking that an insider is confirming what GATA and others have been suggesting for a while: Paulson issues "orders" which are expected to be followed. LTCM was given as an example where everyone but Bear Stearns fell into line to restore order.Keene also points to "mark- to- market" vs "mark- to- model" methods of valuations and associated margins of error; he also made comments about risks associated with derivatives and leverage, to the effect of that any "mistakes" could not easily be fixed, for a lack of time (fractions of seconds now). Very worthwhile interview; the meat of these comments starts in the second half of the interview, starting around 10 mins and 26 secs of the podcast:http://media.bloomberg.com/bb/avfile/BBRECON/va.gpSWoisqQ.mp3

Manipulation/stock market
If you have been reading my musings frequently you certainly are not anymore surprised to see the US stock market miraculously going up the last 30 to 60 minutes on days where the market is practically down the whole day. There were really only a couple of days where this strange pattern did not happen. With the above information it should now be clear who does it. Following background on the President’s Working Group on Financial Markets


The President’s Working Group on Financial Markets (the "Working Group") was established by Executive Order 12631 in March 1988 in response to the stock market crash in October 1987. The chairman of the Working Group is the Secretary of the Treasury, and the other members are the chairmen of the Board of Governors of the Federal Reserve System, the Securities and Exchange Commission, and the Commodity Futures Trading Commission.The Working Group issued its report on the 1987 market crash in May 1988, and conducted follow-up work in 1991. The Working Group did not meet regularly in the early 1990s and was relatively inactive until 1994, when it was reactivated by then-Secretary Bentsen.Although the Working Group was created originally to address issues related to the 1987 stock market crash, it now serves as a forum through which the participating agencies exchange information on and coordinate regulatory policy regarding U.S. financial markets more generally. For example, the Working Group has drafted and proposed legislation designed to improve financial contract netting, and it has written reports and developed recommendations on circuit breakers, hedge funds, and over-the-counter derivatives markets. It also is a forum used to exchange information during market turmoil through ad hoc conference calls and meetings.

China Overtaking Germany as Third Biggest Economy
China's economy is continuing to expand at a blistering rate -- with 11.5 percent growth in the third quarter of 2007. It is now poised to overtake Germany as the world's third largest economy within weeks and will soon also take Germany's crown as the world's biggest exporter
http://www.spiegel.de/international/business/0,1518,513544,00.html

Gray Friday

What happened on Friday?

For the last few days all the news media were reminding us of the anniversary of the Black Monday 20 years ago. Somewhere I was reading that we will have another anniversary the one of the 1907 crash. Well all this anniversary news are not necessary the news to make one comfortable. Knowing that the US market is being kept up in the positive territory in an artificial way by the PPT (aka Plunge Protection Team) does not help neither. Interesting about all this news was that the information given was not so much concentrated on the previous events as such but rather to the way markets recuperated after the event. Well this is a prime example on how to manipulate the masses. The message given in an indirect way is: In case the market would go down – don’t worry! it will go up again. Or; don't worry, be happy!! Well with the kind help of the PPT this might well be the case.
Psychology is certainly an interesting part in the investing world. All this anniversary talk and in addition news of several companies missing their estimated earning targets made some people decide to sell. This might have been the reason that we finally last Friday got a major down move in the stock market. Frankly I was surprised that the market did close down and that the PPT did allow it. Did they lose control? Such a strong down move on an October Friday and anniversaries of previous crashes is definitely bad news and not necessarily positive for investor psychology. I truly believe that the PPT did all they could to keep the market up. Not having been successful leaves me with the question if they lost control. To change the mood back to positive will need not only a FED rate cut of 50bps but as well loads of money, provided by some entity with really deep pockets. Following the markets next Monday certainly will be interesting.

Credits or mark to fantasy

The plans of 3 major US banks who announced that they are leading a consortium in establishing a bailout fund for the commercial paper market seems not to take off well. The question really is who does need this bailout. Is it the companies that need the commercial paper market to get their liquidity? Or is the banks who moved this business from their balance sheet to a separate vehicle SIV? Please reed the following example found on Mish’s blog (by the way an excellent blog with a lot of information) http://globaleconomicanalysis.blogspot.com/
Quote
How Big is the Problem at Citigroup?With a hat tip to Polecolaw for the idea, let's compare net tangible assets at Citigroup to the amount at risk at SIVs and conduits. Let's use $160 billion figure for the combined SIV and conduit numbers and see what comparisons we can find.Citigroup Net tangible assets as of June 30 2007 are $65.5 billion. That's kind of interesting isn't it? Citigroup has $65.5 billion in net tangible assets but $160 billion invested in off balance sheet SIVs and conduits.If a fire sale of those SIVs and conduits resulted in a 25% loss, Citigroup would have net tangible assets of $25.5 billion. If a fire sale of SIVs and conduits resulted in a 41% loss in those SIVs and conduits, Citigroup would have zero net tangible assets.Does Paulson, the Fed, or Citigroup want to find out what those assets are worth? Of course not. That is the reason for a Don't Ask - Don't Sell policy and approval of Enron Style Accounting by Paulson.
Unquote

Mark to Fantasy
Again Mish blog has an excellent essay on this topic. Please check on Mish’s blog.
http://globaleconomicanalysis.blogspot.com/2007/10/marked-to-fantasy.html

About the same topic a remark from http://www.lemetropolecafe.com/
Recently the Financial Standards Board, the private group charged with coming up with rules under which publicly traded companies must report their financial results, issued Statement 157 entitled "Fair Value Measurements." (1) Up until this time companies could generally use either "mark to market" or "market to model" to report assets and liabilities. The latter method is subjective by its nature and prone to abuse. A staff accountant armed with a spreadsheet in the back room can play with assumptions and inputs to gin up the bottom line in a way that allows management to quality for the maximum bonus.
However, in our sophisticated and enlightened business world these two methods were not enough to permit companies to report on their true results. So the accountants obliged by creating a new reporting methodology called Level 3. At the heart of this new "standard" is:
"Unobservable inputs are inputs that reflect the reporting entity’s own assumptions
about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances." (Page 21)
When managers are trying to figure out how deeply to dig to come up with information to verify their unobservable inputs they can use this guidance:
"Therefore, unobservable inputs shall reflect the reporting entity’s own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). Unobservable inputs shall be developed based on the best information available in the circumstances, which might include the reporting entity’s own data. In developing unobservable inputs, the reporting entity need not undertake all possible efforts to obtain information about market participant assumptions." (Page 24,emphasis added)
This last loophole will come in handy when a trial lawyer asks the CFO why he carried Microsoft stock on the balance sheet at three times market value.
It is no surprise that Level 3 was quickly called Mark to Fantasy.
I think it is fair to say that a company will try very hard to classify assets in Level 1 (mark to market) or Level 2 (mark to model). Anything that goes into Level 3 has to be is in a pretty bad state. For example, few CEOs would be willing to take their bonuses in Level 3 assets.
The accountants introduced Level 3 (Mark to Fantasy) at a good time. Martin Hutchinson just published a column (2) that describes the deteriorating quality of earnings and features shenanigans at Goldman Sachs as follows:
"Goldman Sachs, for example, reported this week that the "Level 3" assets in its books, those for which liquidity is lowest and valuation most difficult, had jumped by a third in the quarter to $72.05 billion. These "Level 3" assets presumably don’t include Goldman’s multi-billion dollar holding of the Industrial and Commercial Bank of China, quoted daily on a stock exchange, however over-inflated its share price and illiquid its trading market. Instead, they appear to represent mostly derivatives and securitization assets linked distantly to mortgage loans and leveraged buyout deals, whose valuation is carried out by the operating unit itself, based on the price at which it would have to sell the asset to preserve its bonus pool from unexpected losses.
"Set against Goldman’s capital of $36 billion, that $72 billion is a frightening figure. At some point, probably in a downturn, the real value of those "Level 3" assets will have to be recognized. No doubt the resulting losses will be written off against capital but even Goldman’s brilliant and gloriously paid accountants will find it difficult to write off $72 billion of losses against $36 billion of capital."
So Level 3 assets are twice the size of Goldman’s capital. If the accountants had not invented this timely gift Goldman Sachs would have a negative capital account. I don’t think Goldman Sachs could survive that write down. Goldman has contractual dealing with businesses around the world. All of those contracts probably have provisions that require the parties to stay financially healthy. Negative capital would trigger massive defaults. Many of the businesses, governments and foundations that Goldman does business with have charters that require their business partners to live up to exacting financial standards. If Goldman Sachs had negative capital could it underwrite bonds for California or act as a trustee for anyone?
It appears that the only thing that is keeping Goldman Sachs alive, and enabling its executives to get their bonuses, is an accounting gimmick. If this is correct, the American economy is in very desperate shape.
So these 2 example with looking at Citibank and GS regarding their level 3 accounting shows in my opinion clearly that there are still enormous risk for further write downs. Don’t be surprised if you get across new information with further write downs.

Consumer credits

With the credit problems with mortgages, lower house prices and more restrictive credit policy of the banks, the mortgages cannot anymore be used as cash machine. Many of the consumers with credit needs have lately increased their use of the credit lines of their credit cards. Many of these lines are already at top and using a new card and the new line does not help to solve the problem at all. According to statistics each US citizen (counting children as well) have an average of 4 credit cards, which means that adults use practically at least 6 credit cards on average. So with no mortgage credit increase possibility anymore, 6 credit cards with credits filled up to the top, the car financed and thus having to pay interest on all these credits does for many people not leave much room for new purchases. A lot of those people living on credits do have considerable problems to pay the interests and therefore foreclosures are increasing.
Taking the above into account I believe it is a safe assumption that consumption in the US cannot go on as what we have seen in the past few years. Furthermore I really do not see how companies with an important part of their business in consumer credits (banks, credit cards, car financing etc) will do well over the next couple of months. Personally I certainly would not touch at all GMAC and comparable companies (well the same is true for Fanny Mae although they have a quasi government guarantee)

FED

Bernanke said that the Fed has set up a “crisis center” to handle potential global financial problems - to anticipate them, and to deal with them if they occur. Well if that is true, they certainly have realized that the potential for further trouble is enormous. What does “deal with them” mean? Well more liquidity injection, more money inputs and a lot more inflation (personally I believe we could drift towards hyperinflation over the next years). I hope we will not see pictures as the one below soon. However if the actual trend goes on like now, the green paper with dark ink and the picture past gentlemen on it, will not be worth much anymore in a relative short time. Maybe then using this useless paper as fire material to heat up rooms might make sense.




Rate cut?
With the stock market down on Friday, the possibility for a Fed cut has increased considerably. In case the PPT will not be able to bring the markets back up, the help from the FED will be needed. Will it work this time? Maybe people will start to realize that the FED at some point in the near future will not be able to cut anymore as the will be at a level where simply no more cuts will be possible. That means that although the FED might cut rates it might not have the hoped impact. It worked well the first time but possibly will not do that well from now on. We are in an interesting time indeed.

Currencies

USD RIP. Unless at the G7 meeting some rescue plan is decided (market intervention) the USD seems to be in bad shape. It definitely does not look good at all. Hope you had and still have a good diversification.
If you did not read the following article yet, please read it
http://musingsoffritz-forex.blogspot.com/2007/10/japan-and-china-lead-flight-from-dollar.html

Gold

Gold is moving up step by step. The cartel is trying to push prices down but without success so far. Whenever the gold price moves down a few USD, strong buyers enter via the physical market. Open interest is at or close to all time high. In the past this has been a risk and a sign for a down correction in the gold prices. However this time it looks really different. A short squeeze and therefore much higher prices within a short time is becoming more and more a possibility. A move above the USD 800 mark seems to be only a question of days. It would not surprise me at all to see USD 940 or more until 1st quarter next year.

Oil

Oil moved to a new all time high and the WTI was for a short time above USD 90 / barrel. I have no doubt at all that we will see a price of above USD 100 over the next months. However the charts and the general super positive sentiment regarding higher prices, makes me believe that we are close to down correction in the short run. If we see prices below USD 84 we could go to USD 75 or even to USD 65. Both level would be excellent entry points. Such corrections do not change anything in the secular bull for oil, which in my opinion will stay for years, especially as for this really important commodity the fundamental situation has changed completely. Corrections in fact are healthy.

Oil & Oil Service companies

Of course, Oil companies will earn more money due to higher oil prices. However investing in these companies, one has to take into account the management capabilities, their capability to replace extracted oil (replace reserves). Furthermore one has to know that operating costs and cost to search for new reserved are going up considerably. That means that the margin might not widen considerably in favor of the oil companies. The big companies have several ways to increase their reserves. One would be to search for new reserves which is very expensive the other would be to buy other companies with proven reserves. Therefore smaller and mid size companies might become takeover candidates.
Oil Service are the winners in the actual situation. Drilling and the search for new reserves is hot. As for many years this has not been the case the oil service companies nowadays do have a problem to find capable and trained staff. Due to many years with basically no need for new drilling and therefore no profits for the drilling companies has led to a situation of underinvestment in equipment for about 20 years. The demand for new drilling and services from service companies related to drilling is so high that in my opinion the actual positive trend will go on for years. This is positive for these companies and therefore they should make nice profits.


Social Security system

“Social Security is the biggest Ponzi scheme in the history of mankind”. A quote which certainly is true. Did you know that the first official baby boomer filed for Social Security this week? That means the lady will become the first baby boomer to take advantage of early retirement and to get Social Security. This piece of news reminded me of the fact that soon (in fact very soon) millions of baby boomers will retire (if they financially can) which on one side will mean that millions will start to sell every month some stock in case they have a 401 plan or it will mean that the amounts that have to be paid to retired citizens will increase dramatically. As with most systems that depend on actual payers paying for the retired, the US system had 40 contributors versus 1 receiver when the system started. Today we are close to 2 people paying for 1 retired one. Of course this is not only a problem for the US but as well for many other countries with similar demographics and a similar system.
Well there is a load of problems re financing of these systems. Those who get something out of it can be happy as there will be a lot of people having paid for years but with no or almost no benefit once they would be able to apply for benefits. An interesting video about this and other issues, please watch this video
http://www.grandich.com/video/60min.162mb.wvx