themusingsoffritz: 11/25/07

Dear reader

This week I am bit earlier than normal. My next post possibly will be around December 8.

For all readers who prefer to read my Spanish version, please click on

http://themusingsoffritz-espanol.blogspot.com/

As we approach Christmas time I wanted to start this post with something positive. Therefore my first part is about my favorite investment, precious metals. I am very happy for all of you who kept on the faith in higher gold prices and therefore were not selling when prices did not look that well during the first month of this year. Furthermore I’d like to congratulate all of you who bought on time in order to be on the boat participating on the nice move up the last few weeks. Personally I have no doubt that that the coming years will bring as much happiness to precious metals holders as the past 6 years. 6 years ago we were at USD 260 gold and below USD 5 silver. Well anyway in case we get to a situation like the one on below picture and the economy will hit the iceberg, you will do much better than others with your precious metals holdings. Of course I do hope that we will not hit the iceberg but anyway in case it does I prefer to be well prepared.

FED
From shadowstats.com
Quote
The FED is a privately owned corporation dedicated to maintaining the profitability and solvency of the US banking system. Guidance from the federal government as to maintaining sustainable economic growth and containing inflation are secondary concerns, to which the Fed pays significant public lip service. The simplistic view put forth by the Wall Street is that the Fed can raise rates to contain inflation or cut rates to stimulate the economy. The Fed can do neither at present, despite there being both recession and inflation problems. Further the US central bank faces a severe profitability/solvency problem within its base banking system
Unquote

Yes the Fed is a privately owned corporation with particular interests. Therefore it should not come as a surprise to see that the Fed is always on the side of their owners or Wall Street.

Bloomberg reports, “Fed fund futures show traders see an 86 percent chance the central bank will reduce its target a quarter-percentage point to 4.25 percent at its Dec. 11 meeting, 68 percent odds of another 25-basis-point cut in January, and a 44 percent likelihood the rate falls to 3.75 percent in March.”
Normally, that kind of aggressive rate cutting is good news for the markets. After all, the Fed pumping a little extra cash into world usually helps out the economy and traders love to see the Fed taking decisive action to help out the economy.
However, all those rate cuts are already priced into the stock market, too. It’s safe to say that, without some extreme action, even the Fed won’t be able to stop this downtrend.
The subprime crisis is only going to get worse from here, and now it’s making its way into the rest of the economy and causing the next shoe to drop: the retail sector.
Unquote

The US stock market is addicted to interest rate cuts and therefore the pressure on the FED for another cut is tremendous. The Fed will face a though decision, cut the rates due to the pressure from the market or push the market into an abyss. It seems that the Fed would prefer not to cut at least the signals from them does suggest this. Possibly we will see some nice painted incoming data which should show us that the economy is strong. I doubt that these data will take off the pressure for another rate cut. The stock market simply speaking needs the cut.

Credits
from Jim Rogers:
“This is worse than the S&L crisis. This is the first time – this is the worst credit bubble we’ve ever had in American history. No – never in American history have people been able to buy a house with no money down...never. That’s never happened anytime in the world. So, we have the worst credit bubble . It’s going to take a long time to work its way out. You don’t cure a bubble in five or six months... It takes five or six years
Washington Post: Investors already burned by turmoil from the credit crunch are now worried about unwanted surprises in the industry that insures bonds
Unquote
Week after week, more losses are announced. The latest tally by Goldman Sachs estimates total losses at $400 billion from the subprime debacle, with a total of $2 trillion of cash and credit sucked out of the financial system.
Leverage works in both ways, it turns out. When credit is expanding, a deposit of $10 million can be levered into a $100 million gamble. When it is contracting, a $10 million loss reduces the supply of credit by as much as $100 million. The negative leverage was the problem of the Bearn Stearns hedge fund that got bust a few months ago. With a leverage of 20, working both sides, it means if the bond falls 5% from 100% to 95%, your capital is out.

Fannie and Freddie. The losses for those holding papers of Fannie and Freddie could have been avoided. Once again it shows clearly that one should not be invested in companies/papers that are exposed to an actual or future negative trend. Already 3 years ago I was telling my friends not to touch any of those. Well I certainly was too early but to be honest, I prefer to be early than late.

As mentioned in my last post there is more to come. Now the governor of the Bank of England confirmed it: Worse to come, warns Bank chief
http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2007/11/21/cngieve121.xml

Until now I came across several estimations of the possible losses due to the housing/slow down situation in the US. The estimations vary from USD 100 billions to USD 400 billions of write downs. Boston Globe estimates USD 300 billion http://www.boston.com/business/articles/2007/11/21/us_mortgage_related_losses_likely_up_to_300_bln_oecd/
In fact it does not matter if it is USD 100 or USD 400 billion. In any case we are talking about substantial amounts and huge losses. This will have its impact all over the world. Lucky the ones holding real “stuff” like gold, land and so on instead of worthless papers.

Well well, last week and in previous mails I warned about the frenchies to follow with information about write downs. Natixis is the first one.
http://www.reuters.com/article/marketsNews/idUSL2528735720071125
More and higher amounts to be expected over the coming months.

And last but not least a comment found on lemetropolecafe.com
This guy used to write for TheStreet.com and was their only legitimate journalist. Now he writes for Fortune and this article talks about the next big write-downs for banks will come from CDO structures, many of which are also in off-balance-sheet vehicles known as VIE's - variable interest entities. The accounting for these structures is such that they do not become an issue for bank financial statements until it's too late to save them - we can thank FASB and the SEC for that:
http://money.cnn.com/2007/11/24/magazines/fortune/eavis_conduits.fortune/index.htm?section=magazines_fortune
After the CDO shoe drops, we'll get to hear about credit derivatives and commercial real estate debt explosions. It's been ugly, getting uglier, and will get more ugly.
***

General Trends
One more from lemetropolecafe.com
Forecast: U.S. dollar could plunge 90 pctPublished:

Nov. 19, 2007 at 2:16 PMRHINEBECK, N.Y., Nov. 19 (UPI) -- A financial crisis will likely send the U.S. dollar into a free fall of as much as 90 percent and gold soaring to $2,000 an ounce, a trends researcher said.

"We are going to see economic times the likes of which no living person has seen," Trends Research Institute Director Gerald Celente said, forecasting a "Panic of 2008."

"The bigger they are, the harder they'll fall," he said in an interview with New York's Hudson Valley Business Journal.

Celente -- who forecast the subprime mortgage financial crisis and the dollar's decline a year ago and gold's current rise in May -- told the newspaper the subprime mortgage meltdown was just the first "small, high-risk segment of the market" to collapse.

Derivative dealers, hedge funds, buyout firms and other market players will also unravel, he said.

Massive corporate losses, such as those recently posted by Citigroup Inc. and General Motors Corp., will also be fairly common "for some time to come," he said.

He said he would not "be surprised if giants tumble to their deaths," Celente said.

The Panic of 2008 will lead to a lower U.S. standard of living, he said.

A result will be a drop in holiday spending a year from now, followed by a permanent end of the "retail holiday frenzy" that has driven the U.S. economy since the 1940s, he said.

http://www.upi.com/NewsTrack/Business/2007/11/19/forecast_us_dollar_could_plunge_90_pct/4876

USD
"They get our oil and give us a worthless piece of paper."
This was a remark of one of the heads of an oil producing country. The remark hits the nail on the top. Yes this is certainly a dilemma. However there is already oil producing countries that ask to be paid in Euros’. Those who still get the USD are certainly trying to find out how to get rid of the most successful export article of the US, a paper called the USD. The game is now to get rid of it the fastest way possible, without provoking a further fall in the USD.
The expected FED rate cut in December will not help at all to support the falling USD.
A perfect diversification of course would be gold. Some of the holders of the green/black papers apparently are already diversifying into precious metals at least increasing sales figures of physical gold in Turkey (export to middle east) and China are indicating this.

Liquidity
Well it seems that the cash markets once again are not very liquid.
Troubled-bank borrowing from the Federal Reserve’s discount window is on the rise again, more than doubling, average daily borrowings rose to USD 479 million in the two weeks ended Nov.21, up from USD 191 million.
The FED already announce a new Repo agreement program offering maturities in January 2008. This to avoid possible illiquidity by year end. The European Central Bank ECB is injecting money into the system too.
Fresh emergency action to pump funds into the money markets was announced on Friday night by the European Central Bank amid renewed fears that liquidity in the credit markets is again starting to dry up.
On Friday night the bank said it would inject an unspecified amount of extra liquidity next week, noting "re-emerging tensions" -- and would do so until at least the end of the year.
Earlier, Jean-Claude Trichet, ECB president, had pledged continuing action to keep short-term money market interest rates in line with its main policy rate.
The new promise of intervention came as three-month US interbank rates rose for the eighth day in a row to 5.04 per cent, more than half a point higher than the US Fed Funds target rate of 4.5 per cent….
http://www.ft.com/cms/s/0/6a8adc9a-99b7-11dc-ad70-0000779fd2ac.html?nclick_check=1

Peak Oil
Ladies and Gentlemen the people of India and China are getting their taste of owning cars. This means even more increase of demand for oil out of China and India. Please read
http://themusingsoffritz-peakoil.blogspot.com/2007/11/china-and-india-have-gone-car-crazy.html

Hedge Funds
More than one in 10 of all hedge funds will go out of business this year, suggests Peter Clarke, CEO of Man Group -- the world’s largest hedge fund manager

My guess is that more than 6 out of 10 will go out of business over the next 5 years.

China
Please read the essay from Nouriel Roubini
http://www.rgemonitor.com/blog/roubini/

PPT
Found on the webpage of GATA:
The Bloomberg News Service story appended here is remarkable for its taking for granted the market rigging being arranged by the secretary of the treasury, whereby, at the government's encouragement, the county's biggest banks are colluding to fix the market price of distressed securities, violating the most basic anti-trust law.
http://www.bloomberg.com/apps/news?pid=20601109&sid=a3BygoB.ADZg&refer=home

Equity Markets
According to Richard Russel we are in a primary Bear market.
Quote
The Transports broke under their August 16 low of 4672.35 back on November 7. Today the Industrials finally confirmed, so the bear signal was not given simultaneously. If there is even a hint that this bear market will be "kind," this is the hint, but I'll admit that this line of reasoning may be far-fetched. The fact that we must operate on is that the primary trend of the stock market is now definitely bearish. The great primary trend of the market is pointing down
Unquote
Well, as mentioned above the stock market needs the expected rate cut. Earning reportings from the S&P companies has been considerable below market expectations. This should not come as a surprise to those who are aware that the real US GDP has been in negative territory since 1999 (with the exceptions of only 1 quarter) and that the whole consumption party was only possible due to low interest and willing lenders. Now being in the situation that the US has a negative savings rate and that the lenders are not as willing as before there is simply no cash to be found in order to buy stuff. Making ends meet, with higher costs of all necessary products (food, gasoline) and no source of new funds to borrow, will reduce the possibility to consume and therefore will have an impact on the economy and the results of the companies exposed to the US economy. Of course as mentioned in a previous post, in case the Fed moves further to liquefy the system in order to bail out troubled companies and thus provoking a possible hyperinflation, a much higher DJIA is possible. Although we might see a DJIA at 50,000 or even higher, does not automatically mean that the market value, net of inflation, really has gone up.

Commodities
Checking on Kitco
http://www.kitcometals.com/charts/copper_historical.html
the physical stockpiles for a few industrial metals (as promised in my last post) it shows that apart from Nickel and maybe a bit Aluminium, the physical holdings are still very low. Therefore for the moment being I do not yet see a deaceleration on the demand side.

Why do commodity prices move up and down in such decade-long cycles? Well while commodity production and demand do in fact respond to price changes, there is a long time lag in most cases, particularly with regard to production.
There are many reasons for this. First, because commodity prices fluctuate so much, many producers want to wait and see if we’re really on an upward path before investing. But far more importantly, particularly in the cases of mining and drilling for oil and natural gas, it takes quite a while to find new sources; to determine whether or not mining or drilling is really economically viable; to overcome red tape and objections from government bureaucrats and environmentalists; and then finally to go very deep into the ground and actually extract it. Any of these things can take a decade or more.
Apart from past cycles there is another reason why I believe that this bull market is to stay another 20 years. This is a due to fundamentals. Why that? Well my conclusion is that supply is simply not growing as fast as demand, and won’t do so for another few years, a period during which, therefore, the commodity-price rally will likely continue. Furthermore I do believe in the peak oil theory and that, to me means, we will see higher oil prices and less production which will have an impact on all commodities. In addition to that we clearly can see that finding new resources is not only difficult in the oil&gas sector but as well in the metals mining sector, at least for several of the metals. Yearly gold mine production for example is clearly decreasing and finding new sources is not easy at all. Therefore some people start already to talk about Peak Gold or Peak everything.
Well in a few weeks we will see if a possible worldwide recession will end the commodity bull market or if this correction is only a correction and thus an excellent buying opportunity.

November 27’s action

You certainly got the news that Abu Dhabi helping out Citibank. Following some reactions of members of lemetropolecafe.com
Quote
Based on the implied cost of capital to Citicorp of the $7.5 billion dollar investment by Abu Dhabi, the implication is that Citicorp may be on the verge of insolvency. The deal is structured as a passive, subordinated convertible security with an 11% dividend and is convertible into 4.9% of the Company, based on a price conversion scale that ranges from $31.83 to $37.24 and the conversion expires in Sept 2011. Without further details on the conversion feature, and keeping the analysis "plain vanilla" for these purposes (i.e. we don't have all the terms of the deal and there's some theoretical "nuances" to consider) I'm assuming the average conversion price would be $34.53. And assume Citicorp stock performs such that it is worthwhile for Abu Dhabi to convert into common (i.e. the stock rises above the conversion range by 2011 and I doubt Abu Dhabi would do this if they didn't believe in that event). Based on yesterday's closing price of $30.70, th e implied cost of capital to Citicorp on the conversion feature is 12.5%, plus they've paid out an 11% dividend. That's an all-in cost of capital of 23.5%.
Now, just on the surface, the 11% dividend is similar to the yield that a mid-quality junk bond issuer would have to pay to get bond deal done. But the 23.5% implied cost of capital embedded in this deal reflects the kind of return that would be required for a "vulture" investor to invest in a highly distressed company. In other words, the cost of capital to Citicorp's shareholders of this deal implies that the rate of return required to induce investment capital into the Company reflects an assessment by the market that Citi is on the verge of insolvency. I would be interested to know if the good folks in Abu Dhabi were allowed to see the real "insider" financials at Citi, including ALL of the off-balance-sheet financing structures AND all of the derivatives. Somehow I doubt it....
And from another member
While the popular press is heralding this as a "lifeline from a Middle Eastern nation," I see it as a sign of significant distress at Citigroup. Unless I am missing something, an 11% yield is what one would expect from something in the high risk or "junk" category. To me, this suggests that Citigroup is desperate for new capital
And another memberI see that Paulson's M-LEC is being led by JP Morgan, Citigroup and Bank of America. These are the 3 that have stepped up to sign on first and help encourage smaller banks to contribute to the SIV Fund. Yet, these are the 3 biggest derivative holder and have the most at risk. These are heroes. These are scam artist trying to encourage others to contribute to their Personal Charity Fund. Sounds Ponzi to me