Andy Sutton's Extemporania

Weekly Commentaries and Occasional Observations

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Tags: energy

Congress Deserves an Oscar for AIG 'outrage'

by TwoCentsEditor

Published on: 03/18/2009

Categories: Current Events

Comments: 4 Comments

Politicians on Capitol Hill have done their very best to muster up an acceptable amount of rancor over the AIG bonus checks that went out last week. Ironically, the gang of 535 are more interested in getting back $165 million than finding out where the TRILLIONS in Federal Reserve ‘gifts’ to big banks, brokerages, and other financial institutions have gone.

There is no need for any of this political grandstanding. The US Government owns a near 80% stake in the failed insurance company and as such could simply retract the bonsuses through a shareholder action. There is no need for hand-wringing, negotiations, or incessant hearings on Capitol Hill.

Secondly, the chief of AIG insisted that “when you owe someone money, you pay it back” referring to the fact that these bonsuses were contractual agreements. However, the Congress has had no problem suggesting that bankruptcy judges modify subprime residential mortgages (which are also contracts), so the small matter of the $165 million shouldn’t be an issue from a contractual standpoint.

Perhaps most importantly, the AIG bonus situation is non-issue in comparative terms and is meant to absorb the public’s outrage while the vast majority of TARP and other Fed disbursements go unaccounted for. By my calculation, the $165 million is exactly .61% of the money that has been spent in the people’s name so far (that we know about) in dealing with the financial crisis.

The hystrionics of both political parties are a nice piece of acting, but should further establish that they are much more interested in protecting the status quo than the US taxpayer.

A Game of Confidence

by TwoCentsEditor

Published on: 02/27/2009

Categories: Current Events, Economics, My Two Cents

Comments: 4 Comments

A scan of the financial and economic landscape of any society during solid, genuinely prosperous times will always reveal a populace brimming with confidence. Confidence in their ability to make a living, confidence in the ability of their leaders, confidence in the workings of their financial markets to whatever extent they exist, and ultimately confidence in the strength of their money. These factors are all interlocking directorates; take any one of them away and you’ll witness an economy that is no longer efficient and begins to stumble. Take them all away and you’ll witness unbridled economic chaos.

It is the latter statement that causes me to reflect this week on the prospects for our return to prosperity. We have had the opportunity over the past year to listen to many speeches from Presidents to heads of Treasury and the Federal Reserve. Many men and women – bright men and women, have weighed in and opined on our current situation. They’ve spoken of stimulus, of consumer spending, government spending, bridges, roads, healthcare, energy, banks, and many other topics too numerous to count in this short space. However, what I haven’t heard nearly enough mention of is confidence even though the stated purpose and intent of these speeches has been to inspire the same.

The confidence of consumers

One report in particular has made some inroads in terms of getting coverage of the precipitous drop in overall consumer confidence. And in fact, the most recent release of the Conference Board’s measurement of consumer confidence was the worst in history since measurements began more than 40 years ago. Perhaps the worst part of this report was the expectations component, which absolutely fell off a cliff, plunging from a level of 42.5 to a 27.5 level. The jobs component of the report was no better. 47.3% of those surveyed expect there to be fewer jobs in the future with a mere 7.1% expecting more jobs. 4.4% thought jobs are easy get with nearly half (47.8%) opining that jobs are very hard to get. The chart below tells the awful story.

Consumer Confidence Chart

It is fairly easy to see how the lack of confidence has translated into overall drops in retail sales. Sure people are spending less for gasoline (a major component of retail sales) than they were a year ago, but they certainly aren’t buying anything else in its place either.

This situation, however, goes way beyond some numbers reported every month. It goes to the very heart of the opening paragraph. Confidence is the key to a successful economy, particularly ours, which is so heavily dependent on the consumer taking on debt and spending money. In order to perpetuate this dynamic, the consumer needs to have utmost confidence. As last 2008’s failed stimulus package demonstrates, simply handing money to consumers who are not confident will result in the money being saved or used to pay off existing bills. No confidence, no spending. It’s as simple as that.

Collapse of retirement contributions a referendum on confidence in the financial system

Whether it is along with, beside, or because of consumer’s confidence, equity markets on a global scale have crashed in grand form over the past year. Sure, not all of that was caused by the little guy selling his 401(k)/IRA and going to cash. It is our opinion that the little guy actually represents a relatively small component of the overall money invested in the markets when leverage is factored in. However, the little guy’s actions have still had major ramifications. Consider the following:

• 529 plan contributions are down an average of 60% from 2007 according to a 529 plan representative who materialized at my office door a few weeks ago

• According to TD Ameritrade, 63% of people with retirement plans stopped contributing to them in 2008

• Only 21% of individuals surveyed in the above study had more than $50,000 in investable savings

• Unemployment (32%) and increases in health care premiums (25) were the leading reasons why people stopped contributing to retirement plans in 2008

• Nearly 25% of survey respondents in the 35-44 age group said they’d completely stopped contributing to retirement accounts in 2008. This more than any other group

While complete data for 2008 contributions is incomplete due to the fact that 4/15/09 is the deadline for 2008 IRA contributions, it is relatively clear that 2008 contributions will be down significantly. This problem is two-fold. The first is many people don’t have the funds to invest. The second is that they have lost confidence in the markets and their ability to protect (let alone grow) capital. This reality is unfolding at an unprecedented time in history – a time when people can least afford to be caught without savings.

Job loss – the ultimate confidence-killer

As now more than 600,000 Americans each week are realizing, the loss of a job is one of the most stressful events one can endure. There is an old adage that it is a recession when your neighbor loses his job, but it is a depression when you lose yours. This is not meant to trivialize the matter of unemployment in the least, but rather to underscore the effect that the loss of one’s livelihood has on confidence. As can be expected, consumer confidence has plunged as job losses continue to increase.

Unemployment Graph

Next Friday’s unemployment report is likely to feature an unemployment rate well north of 8% not counting the thousands of workers who lost their jobs in late 2007 and early 2008 that have now fallen off the unemployment rolls and as such are no longer counted. By our count, there have been nearly 2.4 million first time claims for unemployment in the past 4 weeks alone and the trend shows no signs of slowing, at least not in the short term. While unemployment insurance lasts up to a year (depending on the state), it only covers a portion of lost earnings. A good average is probably around 60%. I don’t know about you, but I don’t know too many people who can maintain their current standard of living on 60% of their income – or are even willing to try.

Money – A True Crisis of Confidence

Confidence in the monetary system of the United States has been a true lagging indicator. Inflation at a rate of 5% or so per year has been institutionalized in the system for as long as anyone can remember. Keynesian economics teaches us that this inflation is a normal by-product of growth and should be accepted with glee, which is absolute nonsense. This is akin to welcoming a burglar into your home and offering him 5% of your belongings then chalking it up as a cost of living.

However, even the most regular of folks are starting to wonder where the trillions of dollars for their retirements, healthcare, financial system bailouts, various industry bailouts, state bailouts, government spending, and other pet political projects are going to come from. The fact is we’ve crossed the Rubicon in this regard. The world no longer creates enough savings to cover our massive balance of payments and fiscal deficits. And remember, one in three Americans have less than $50,000 in savings to deal with this. Everyday Americans are starting to wake up to the reality that this money doesn’t exist and must be created from nothing. That certainly doesn’t bode well for their confidence in the value of the currency they carry in their pockets. It can no longer be called money, because to call it money is to imply that it is a store of wealth and acts as a standard unit of exchange.

A real store of wealth holds its value and maintains purchasing power. The US dollar has lost around 96% of its purchasing power since the Fed was created in 1913. Other paper currencies are not far behind. This reality has driven record demand for gold and silver coins as the public awakens and attempts to diversify out of paper. This overall loss in confidence in paper assets is what drives mainstream columnists to attack gold as a ‘useless rock’ and float the false notion that people who bought stock after the 1929 crash got their money back in a few years when in fact it took a few decades. Remember, it is all about confidence.

In the end, the financial crisis of 2007-? will be summed up as a fairly simple process:

1) Confidence shaken

2) More debt accumulated to maintain confidence

3) Confidence further shaken

3) Even more debt accumulated

4) Confidence lost because of all the debt accumulated

For in fact during the early stages of the crisis, policymakers and pundits alike were busy talking about strong economic fundamentals and failing to address the root causes of the problem when it might have mattered. For nearly 9 months the current depression brewed before Fed head Bernanke and Treasury Secy. Paulson were even willing to admit that a problem existed outside the banking system. The entire sum total of their efforts was to maintain confidence. It was a dangerous gamble that has proven disastrous and they’re about to learn the hard way that while you might be able to create a bailout for big banks and big government, there is no bailout for confidence.

Don’t miss out on your free copy of our report “The 7 Mistakes Investors make..and how to avoid them”. Get your copy today by going to our website www.suttonfinance.net and clicking the free report banner.

Disclosures: Long GDX

Another Hit and Run

by TwoCentsEditor

Published on: 02/13/2009

Categories: Current Events

Comments: 12 Comments

In eerily similar fashion to last fall’s financial system bailout, the American people are once again having another piece of legislation jammed down their throats without their elected representatives even having a chance to review it. This by a new administration; one that promised that such things were of the past. However, when it comes to pork, all politicians are the same and this new stimulus bill has now grown to well over 1000 pages in the hours before the final vote.

The bigger question is how could an elected representative in good conscience vote for something they haven’t even had a chance to look at? At the very least, this is despicable behavior. This bill of goods has been sold under the premise that if something isn’t done within days that the economy will collapse. This is utter nonsense and fear-mongering – nothing more. An economy doesn’t collapse over a period of days. It has taken us well over 2 years from the beginning of the blowup just to get to where we are now. Certainly a few weeks could be taken here to at least give due diligence before committing the equivalent of fiscal suicide.

Unfortunately, by the time we actually learn about the content of this ever-changing bill, and its ultimate impact on us as citizens, the time for action will be long gone.

And the numbers keep growing

by TwoCentsEditor

Published on: 02/09/2009

Categories: Current Events, Economics

Comments: No Comments

What started out about this time last year as a $168 Billion attempt to revive us from a recession that at the time didn’t even exist (according to Washington and the media) has grown into a mammoth rescue which to date commits US taxpayers and future generations to nearly 58 times that original amount.

This amount is enough to pay off nearly 90% of US mortgages according to Bloomberg. Has anyone ever thought that it might not be a bad idea to do exactly that? Since we’re going to spend this money on consumption anyway, it makes sense to maybe relieve the average American of a little financial strife.

Let’s extend that for a second to all the bad debt floating around the financial system. Debt that the government is frantically trying to figure out what do with. Did it ever occur to anyone to ask why some of those debts are bad? Sure, a good portion of it is due to derivatives and other bets, but at the very least some of it is consumer debts that cannot be paid because of job losses, irresponsibility, variable rates, etc. Helping the consumer would help the system by making at least some of these debts manageable.

It becomes important to understand the differences between consumption and an economy. Anyone can consume. Demand is virtually unlimited. Given someone a boatload of money and they’ll probably end up buying much more than a boat. Even under the best of conditions this would be foolish because it incentivizes laziness. However, in our current model, it does virtually nothing since a good majority of our products are manufactured overseas anyway. So borrowing and spending a trillion dollars might cause a bit of temporary consumption, but do little to sustain an economy.

If we’re going to do a bailout anyway, again, why not start with consumers and rebuilding our productive capacity.

Income in a Zero-Rate World

by TwoCentsEditor

Published on: 01/30/2009

Categories: Economics, Financial Markets, My Two Cents

Comments: 1 Comment

One look at the yields on US Treasuries tells a good part of the story. Listening to Fed Chief Ben Bernanke gives us the rest: it is going to be very hard making any kind of money in many traditional fixed income instruments using the conventional method of clipping bond coupons. Certificates of Deposit won’t be much better moving forward. It would seem as though we are destined for either zero or near zero short-term interest rates for at least the next year.

At the same time, equity markets have been atrocious. That goes without saying. And it hasn’t just been the US markets either. International indexes have been decimated. Commodities, save Gold, have been hammered as well. There are always FOREX markets, trading options, and futures, but they are risky and often outside the comfort zone of the average investor. So the big question right now is how does one aspire to make any money in the markets given the current realities? Fortunately, there are a couple of strategies that are relatively easy to implement for the average investor. We’ll outline two of them here.

The hedged dividend Portfolio Model

The first is to create a situation where the investor is able to secure a higher rate of dividend income than that of traditional fixed income investments while significantly decreasing the risk to the portfolio. In order to do this, a portfolio of dividend paying assets is selected, and an appropriate hedge is identified to protect the investment. This allows the investor to get a comparatively high dividend yield while providing a higher degree of capital preservation than would otherwise be possible.

The problem with hedges is that markets don’t always go down, nor do they always go up. Obviously, when markets are moving higher a hedge will be a boat anchor on any portfolio. Conversely, the absence of a hedge in a falling market will also be a boat anchor. The challenge is identifying the bigger moves and acting accordingly.

Back in December, we took at a look at some model portfolios that were based on the investment themes focused on by the financial media during 2008. Of the three, let’s focus in on the energy portfolio, simply because it paid the best dividends of the three mentioned in that article:

Security	Symbol	5/19/2008 Price	11/20/2008 Price
Penn West Energy Trust	PWE	$33.83	$12.42
PenGrowth Energy Trust	PGH	$20.84	$7.84
Baytex Energy Trust	BTE	$29.20	$12.09
Harvest Energy Trust	HTE	$25.52	$9.20
Schlumberger	SLB	$106.63	$40.02
Permian Basin Royalty Trust	PBT	$24.74	$16.27
Kinder Morgan	KMP	$60.22	$45.37
Buckeye Partners	BPT	$49.11	$27.77
Ultrashort Oil&Gas ETF	DUG	$26.69	$49.57

This model contains 4 Canadian Royalty Trusts, an oil service company, two Master Limited Partnerships (MLP’s), and an express Trust. The model is heavy on the side of Canadian Royalty Trusts because they have been a popular vehicle for individuals to invest in oil and natural gas.

This model portfolio paid $19.98/share in dividends during the course of the period studied.
The assumption for the portfolio is that an equal number of shares were purchased for each issue listed. Let’s say for example that we purchased a round lot (100 shares) of each and a 16% hedge (250 shares) of DUG.

The initial cost of our portfolio on 5/19/08 (recent market high) would have been $41,681.50 plus any applicable commissions. The November 11/20/08 value (recent market low) was $29,490.50 for a loss of $12,191.00 or 29.25%. The dividends paid during that time would have totaled $1,998.00, a yield of 4.79% for just 6 months. Considering the S&P500 lost 47.25% during the same period, the hedged strategy performed much better and produced dividends at an annual rate of 9.58% as well.

Obviously, if the price of oil and natural gas had continued to rise, this would not have been an appropriate move since we would likely have gotten capital appreciation in additional to the dividends but the hedge would have lost significant value. The obvious risk to this type of an approach is that the incorrect hedge is used or a major market signal is missed. The whipsaw of the energy markets underscores the need to be up on the wheel in terms of keeping up with this type of a strategy. While it can certainly pay off, like anything else, it requires constant vigilance. The benefits are obviously the dividends and the knowledge that even if you don’t nail every move; you are still getting paid handsomely to wait until market conditions become favorable. And in the case of energy, you have the conviction of the belief that you are investing in a wasting asset that is becoming more and more difficult to get to market.

Income through covered calls

A second method that investors can use to make money on investments they hold is by writing covered calls. It isn’t as complicated as it sounds. In the interests of brevity, I will present a short primer of how an option works, focusing on calls for the purposes of this article.

A call gives the holder the right to purchase 100 shares of a stock at a given price, or ‘strike price’ for a period of time. For this option, the purchaser pays a premium. Let’s use an example to illustrate. Joe buys a call for Company XYZ at a strike price of $30 that expires in 3 months. The current share price is $28. Joe is speculating that the price of the stock will go up within the next 3 months. If indeed that happens, he can either sell his option to someone else (if it appreciates in value) or, if the price of the shares goes above $30, he can exercise his option, purchase the shares at $30 then sell them on the market for a profit. However, if the share price doesn’t move or goes down, Joe’s option will expire worthless.

Now let’s flip the roles and look at it from the standpoint of the investor who holds the shares. Let’s say that Joe buys 500 shares of XYZ stock at $28/share. What he can do is sell 5 calls (each call is an option on 100 shares) at a strike price of say $35. For selling these options, he’ll receive the premium, which will vary on a number of items such as the volume of options at that date and strike price, the time involved, and other factors.

Joe’s calls are ‘covered’ because he already owns the shares. If the option is exercised, he’ll just surrender his own shares as opposed to having to go out in the market and purchase them (naked call).

In the ‘worst’ case, the stock price rises to the point where the option holder will exercise and Joe will have to sell his $500 shares at $35/share. However, he not only received the premium from selling the options, but he also made $7/share. So his profit is $3,500 plus whatever he made selling the options. If the stock stays under $35, the option will expire unexercised and Joe can sell 5 more covered calls and bring in more premium. For stocks that are stuck in a range, this is a great strategy. Applying this strategy to a dividend-paying portfolio is a great way to enhance income, especially in a down market such as what we are dealing with right now. By combining this tactic with the hedged portfolio presented in the previous example, a fairly stable basket of dividend producing assets with extra income from the covered calls can be created.

Some things to consider

• It is a good idea to sell calls at a strike price that is significantly above what was paid for the shares. The example above is a reasonable one. If the strike price is too close to the current market price, you stand a better chance of getting blown out of your position. You’ll likely bring in more in premium for those options, but the likelihood of losing your position must be weighed. This is especially true if the intent is to collect dividends and supplement the dividend income with covered calls.

• Tax implications must also be considered. Generally for IRA type accounts this is not an issue as all taxes are deferred anyway. However, in the case of an individual taxable account, Joe’s $2,500 gain would be taxed as a capital gain. The amount of time Joe held his shares would determine whether he’d pay the short or long term rate.

• Writing uncovered or naked calls is not generally advisable and is typically more risky because the writer of the naked call has to have the money available to purchase the shares to sell should the option be exercised. For an investor who is looking to augment dividend income, writing naked calls is probably not a great idea.

If there is one silver lining to the current zero-rate environment, it is that consumer prices have not gone ballistic at the same time. The reduction in energy costs have helped consumers immensely and slightly lessened the need for inflation fighting 10-15% returns (see table below).

Observed Inflation Rate	Tax Bracket	Return required to break even
5%	28%	6.94%
7%	28%	7.92%
10%	28%	13.89%

However, by seeking out these types of returns anyway, investors can begin to either recoup some of what they lost in 2008 or prepare for a future that is at best unclear. Based on recent money supply figures, the assumption that we will once again be entering a period of high inflation is a pretty good one.

Perhaps the most important take home message from this article is that when you buy a stock you become an equity owner in that firm. And it is my belief that equity owners should share in the profits of the firm rather than resting their success solely on the hope that someone will come along at some point in the future and give them more for their shares than they paid.

It must be noted that these strategies are not suitable for every investor. The model portfolio in this article is used for informative and illustrative purposes only and should not be taken as an investment recommendation or offer to buy or sell any security. Always consult a qualified financial professional before making any investment decisions.

Disclosures: Long PWE, HTE

" A Contrarian's Viewpoint Of Technical Analysis In Today's world"

by admin

Published on: 01/28/2009

Categories: Uncategorized

Tags: bonds, commodities, Economics, economy, energy, finance, gold, investing, money, oil, penny stocks, silver, stock market, stocks, Technical Analysis

Comments: No Comments

When I broke into the stock market in 1961 if you wanted to learn technical analysis you were immediately pointed to Edwards & Magee’s book,” Technical Analysis Of Stock Trends” which was the bible of the industry from its first edition in 1948 until its last edition in the 1970s. Of course technical analysis really got its formal start with the publication of the famous “Dow Theory” in a series of articles written by Charles Dow in the Wall Street Journal between 1900 and 1902.

However, until the 1970s technical analysis was frowned on by the street as being somewhat akin to astrology. Then for reasons that I don’t pretend to understand it suddenly became respectable. This respectability has come at a high cost. As a contrarian I regard today’s popularity of technical analysis as a curse and not a blessing. The founders of technical analysis regarded it as a tool for an elite minority in a world in which fundamental anlaysis reined supreme. They regarded themselves as savvy predators who would hide in the weeds and knock off the big game fundamentaltists as they came thundering by with their high powered technical rifles.

As many Wall Street professionals are only too well aware of, the more popular a market indicator becomes the more useless it becomes as a profit making indicator as every Tom, Dick and Harry jumps on the hitherto sucessful indicator and beats it to death. To put it simply what everybody knows isn’t worth knowing. It is what everybody doesn’t know that is of decisive importance.

Regretably, the current overpopularity of technical analysis is not its only problem from the contrarian viewpoint. Other very ugly problems exist. The worst of these problems is today’s overwhelming domination of moving average charts. This domination is recent. The final edition of Edwards & Magee’s book contained a remarkable 324 charts of which only 49 charts were moving average charts. These were stuck on at the end of the book as a sop to the growing power of the moving averages crowd. The earlier works contained far fewer moving avearge charts. Technical analysis was regarded by the old masters as an art that had to be mastered. In those days before the triumph of moving averages swept everything before it a technician was an expert in “pattern recognition analysis.” He was someone who had a hard earned ability to analyze bullish or bearish chart patterns. Among the more common types of patterns that technicians had to be able to master were head and shoulders, tops and bottoms, W patterns,triangles,rectangles,wedges, fans and gaps.

The trouble with moving averages is that they are way too popular and even worse way too easy to analyze. Let’s be honest! How much talent does it take to analyze a moving average? Not much. And everyone who looks at a moving average sees the same thing. The stock is either above the moving average or below the moving average. The triumph of technical analysis and moving averages has resulted in the worst of all worlds. A world in which everyone sees the same thing and what is truly ugly acts on it. If you are technician who uses moving averages what is your edge?

The edge that the founders of technical analysis once had is now gone. Even worse there is reason to believe that technicians are now the prey of choice for a new group of predators who are hiding in the weeds and who’s favorite big game animal is the technicians who are now kind enough to show the world their poker hand. Or is it just my imagination that stocks are no longer breaking through their moving averages with the power and authority that they used to? Those long decisive runs which are the bread and butter of technical analysis seem to occur less and less. Could the reason be unseen predators? How difficult is it today for savvy predators with enough capital behind them to lie in wait until the final minutes of trading and then “paint the tape” with their concentrated action creating a false breakthrough. Knowing full well that many technicians will fall into the trap like plump pigeons. After the trap is sprung of course the stock reverts back to its old mean.

What is to be done? I have two answers and you are not going to like either of them. As a contrarian I am obsessed with seeking out and finding valid metrics that are either ignored or unknown by the public. If you see what everyone else sees you have no edge. At all costs you must find an edge. You must find metrics or indicators that are valid and don’t appear on everyone’s radar scope. My first suggestion is to use Point & Figure charts. I know what you are going to tell me. Point & Figure charts went out with the horse and buggy. They are way too simple. Why they don’t even have Bollinger Bands or MACD. No serious technician would consider using something that pathetically simple in today’s modern world. Exactly! That’s the whole point. I would like to remind the reader that technicians were using Point & Figure charts with success for generations until moving averages swept away all the alternatives. To the best of my knowledge the most recognized proponet of Point & Figure charts today is Jim Dines of the highly regarded Dines Letter. The dean of investment letters Richard Russell also uses Point & Figure charts on a fairly regular basis. If you thought my first suggestion was horrifying. You are going to love my last suggestion. As I am writing these words I have a comical image of a hardcore technician blasting out of his chair in outrage and doing a triple summersault and bouncing on his head three times.

My last suggestion is that when a stock drops below its 200 day moving average it should be regarded as a bullish rather than a bearish event. There I said it. Before going nuts I challenge the reader to pick at random a dozen 5 year, 200 day moving average charts and too see them for the very first time. Ask yourself a revolutionary question. Why isn’t it better to buy a stock when its selling below its 200 day moving average rather than above its 200 day moving average. Study the charts and see them for the very first time. I told you I was a contrarian. We are always told that we should buy low and sell high. Now is your chance. Wen we buy above the 200 day moving average we are buying high in the hopes of selling to an even greater fool. Think about it!

Fred Carach is the author of the book “Forty Years A Speculator.” To view his blog, Click Here

Top Stories of 2008

by TwoCentsEditor

Published on: 12/24/2008

Categories: Current Events, Economics, Financial Markets

Tags: commodities, Economics, economy, energy, finance, investing, money, natural gas, oil, stocks

Comments: No Comments

12/24/2008

2008 will likely go down in history as the year when all those dire predictions made by Austrian thinkers over the past few years finally came to pass. Decades of excesses finally caught up to America, and in traditional fashion, those in authority tried valiantly to negate those excesses with even more of the same. So, to conclude the year, we’ll dig into some of the top stories of 2008. Next week we’ll discuss the top stories of 2009 and how they are likely to shape our country and world moving forward.

#4 – The Fed blows up yet another bubble

Conventional wisdom said that the Fed was out of bubbles to blow up once the housing market fell apart (and continues to do so). True, the home was probably the most convenient way that people could be cajoled into borrowing money on ‘equity’ that in fact never really existed to begin with. However, the Fed properly understands the relationship between debt and economic growth in a fiat monetary system. As such, Fed governors know that the American public must continue to borrow money. They also know that the US government, like consumers, is flat broke and needs to borrow money. So the Fed is now using its member banks to indirectly monetize debt. Put simply, the Fed creates money from nothing, then exchanges it for bad assets on the balance sheet of its member banks. The banks get rid of the toxic assets, then take the Fed’s new money and buy US Treasuries. The government ends up with the fresh money, and you the taxpayer have not only the responsibility to pay the principal back, but also to make interest payments to the Fed (vis a vis its member banks) in the meantime. In doing this, the prices of US government bonds have gone parabolic, and correspondingly, yields are now scraping against the ocean floor.

The net result of this is that savers are further punished by near zero or even negative rates of return on short-term money market instruments and other debt that as recently as a year ago were paying north of 4% interest. On the consumer side of things, mortgage rates have dipped significantly. The idea here is to stimulate borrowing by creating (once again) artificially low interest rates. Doesn’t this sound familiar – a la 2001? One problem is that banks are not lending like they were in 2001. Ironically, they are invoking lending standards again even though the Fed has almost completely eliminated risk from the equation! While money is available, it is generally available to only those with the best credit at the lower rates. The rest it seems need not apply. On the other side of the ledger, consumers are in much worse shape overall than they were in 2001. In many cases, mortgages are underwater, there is no ‘equity’ to be tapped, and credit card balances are higher than ever. In addition, the one means of supporting a debt lifestyle (employment) is being yanked out from under many people as weekly unemployment claims and monthly job loss numbers continue to mount at an alarming rate.

#3 – Energy price whiplash

From the perspective of energy prices, 2008 was a tale of two cities. For the first six months of the year, the headlines were about rising oil prices, potential shortages, and record gasoline prices. The second half the year featured a complete 180 degree turn with the entire move from January 2007 through July 2008 being erased and then some. As I pen this article, prices are threatening the $35/bbl level for crude oil and $5.50 for natural gas. In typical fashion, the financial media once again missed the real story here. The post-election revelation that the US has been in a recession since at least late 2007 was no real surprise to many of us, but underscored one of the points we have tried to establish all along in these weekly commentaries. Inflation is a monetary event, not an economic one. The fact that the largest run-up of oil prices in history came at a time when the US was in a recession throws water all over the idea that increasing prices are caused by economic growth alone. As has now been proven rather nicely this past year, that assertion could not be more wrong.

However, the real story behind the violent gyrations in oil prices and the markets in general is two-fold. First, the gyrations are indicative of a dying monetary system and rampant misinformation as ‘investors’, under the influence of mainstream media race first in one direction, then in another in a frantic attempt to predict the next bubble. These are the dynamics that have caused massive dislocations in bonds, stocks, currencies, and commodities over the past year. The fiat foundation is shaking beneath us. Secondly, the dynamics of petroleum supply are fragile, and such violent price swings and false market signals will have dire consequences moving forward. This issue will be discussed in greater detail next week, but in simple terms, we will see petroleum shortages because of this mess – likely in the next year to 18 months.

#2 – Congress – Out to lunch

If Congress’ approval rating was at an all time low going into this mess, it will be interesting to see what its approval rating is coming out of it. In our experience, it is very difficult to find two people to rub together who feel Congress has done a good job for the American people. Whether it is the financial industry bailout, the auto bailout, energy policy, Congressional raises, or a myriad of other issues, 2008 has been a year where Congress has earned it self a big, red F- as public servants. Congress’ actions this year are not a cause for much optimism moving forward. There is no doubt now that we are facing a crisis unlike anything seen in the last 100 years. There is little doubt amongst most of us that we are in no way ready to deal with it. We’re certainly able, but not ready.

Unfortunately, when it comes to getting common sense policy, don’t look towards Congress. Common sense policy would require a significant degree of economic pain for Americans. Congress is in the business of appeasing, not causing economic pain, and as such is impotent when it comes to solving any of our problems – financial or otherwise. Any decisions made by the 534 (minus Ron Paul because he knows what needs to be done) will be an attempt to further postpone the inevitable, and ultimately, will end up making it worse. While the ineffectiveness of Congress is not a story in and of itself, nor should it be a surprise, it serves as a confirmation of the belief that in a crisis, Congress almost always does the wrong thing.

#1 – Banks stay silent on bailout and Fed money

Thankfully, this is a story that the mainstream financial press is actually starting to pay some attention to. A few weeks ago, Bloomberg news filed a Freedom of Information Act request for full disclosure by the Federal Reserve for the trillions in loans it has given out. It must be remembered that these trillions are totally separate from the $700 Billion authorized by Congress in early October. The flimsy excuse given by the Fed for telling both Bloomberg and the American people to fly a kite was that they didn’t want to cause ‘anxiety’ in the markets. If people knew who got the money, then they might actually be able to make informed decisions regarding the health of those companies. Can’t have that, can we? So instead, the Fed has maintained a cloak of secrecy, which has served the purpose of spooking the entire market. This lack of transparency is partly responsible for getting us into this mess. Of course, even more of it will get us out of the mess. That seems to be the prevailing logic at work these days.

But there is more to the story.On 12/22/08, The Associated Press, to its credit, released a story about what is going on with regard to the more widely understood $700 Billion financial rescue package. At least in the case of this money, we have an idea of who got what. Unfortunately the transparency stops there. Here are some notable quotes from banking executives regarding TARP funds:

“We have not disclosed that to the public. We’re declining to.” Thomas Kelly – JP Morgan Chase – rec’d $25 Billion from the TARP

“We’re not providing dollar-in, dollar-out tracking.” Barry Koling – SunTrust – rec’d $3.5 Billion from the TARP

“We manage our capital in its aggregate.” Tim Deighton – Regions Financial – rec’d $3.5 Billion from the TARP

This is the attitude that the big banks have towards you, the taxpayer, who saved their jobs, their billion dollar bonuses, and their companies. The frightening thing about this situation is that the hubris of the financial industry as a whole has continued to mount despite the fact that they are constantly having to beg Congress for more of your money. Where has this money gone? At this point, the only valid assumption, in the absence of disclosure by the banks, is that the money is being stolen. The increasing likelihood that we are witnessing the biggest bank robbery of all time makes this story a dead wringer for #1.

Please accept our most sincere wishes for a joyous Christmas season and a healthy New Year – from all of us at Sutton & Associates and “My Two Cents”.

The more things change…

by TwoCentsEditor

Published on: 08/22/2008

Categories: Current Events, Financial Markets

Tags: commodities, energy, financial companies, stocks

Comments: 5 Comments

..the more they stay the same. I returned from a 5 day respite to find that government officials are still telling us inflation will subside, oil is still being hammered based on the aforementioned assertion, and we will have a strong Dollar ad infinitum.

Despite the happy talk, markets had a down week following what appears to be the conclusion of the bear market rally. We discussed the termination of this rally in depth in our last issue of the Centsible Investor and positioned our Model Portfolio accordingly.

Interestingly enough, while away, I had the pleasure (or displeasure) of being able to get CNBC. In the interests of relaxation, I tuned in 3 times per day for about 5 minutes each time. I did this to watch the major markets, precious metal prices, energy, and interest rates. Oddly enough, almost every time I tuned in, there was a guest on stating 1001 reason why everyone should now own financial stocks. The blatant pushing of these stocks when the worst economic conditions clearly lie ahead would be humorous if so many people weren’t falling for it.

Dollar benefits from bad news

by TwoCentsEditor

Published on: 08/08/2008

Categories: Current Events, Economics, Financial Markets, Foreign Exchange Markets

Tags: dollar, energy, foreign exchange, oil, stocks

Comments: 3 Comments

Dollar bulls beware; the buck is benefitting from bad news around the globe much more than it is returning to prominence. Take a minute and return to fundamentals. The economy is in recession. Unemployment is rising. Consumer prices are up sharply. Foreclosures continue to mount. Home values are falling. Banks are failing. The only thing that has remained the same is the Fed is allowing the money supply to continue to grow at a double-digit rate. The Dollar is being devalued before our eyes, yet we hear an almost endless line of commentary about our ‘strong Dollar’ policy.

In other news, oil continued to exhibit weakness which has fueled world equity markets to pare 2008′s losses slightly. Consumers may benefit from lower gasoline prices for a while during this correction, but don’t count on too much. Lower prices will increase demand as people, eager to return to life as usual ,take to the roads for late summer trips. Regardless of what happens in America, Asia continues to grow. Absent a significant decrease in growth in the Orient, demand will continue to exceed supply. Another possible nasty side effect is that lower prices might discourage further investment, just at the time we need it most.

Oil swoon fuels bank rally

by TwoCentsEditor

Published on: 07/23/2008

Categories: Current Events, Economics, Financial Markets

Tags: Economics, energy, financials, oil, stocks

Comments: 4 Comments

As we’ve watched the recent rally unfold, it has made total sense that falling oil prices would be the fuel. Lower oil and gasoline prices are politically favorable and benefit politicians as they come with hat in hand to beg for votes come November. What caught nearly everyone by surprise though was the trigger for the rally. It wasn’t some big news event. It wasn’t some fundamental change. It certainly wasn’t the explicit guarantee from Secy Paulson that the government would sop up whatever worthless debt Fannie and Freddie have on their books with fresh, unbacked Dollars.

Rather, it took the SEC’s announcement that it would selectively enforce a standing rule and ban naked shorting of the financial stocks for 30 days to throw this temporary floor under the embattled sector. The rout of oil has added fuel to the fire. However, sooner or later, myopic traders will figure out two things:

a) There are still a ton of problems to befall the financials – this crisis is nowhere near over;

b) if our oil prices get too low, the supplies will go elsewhere.

Remember the demand is 87 million bpd, supply is 85 million bpd. Despite media assertions otherwise, US demand has not fallen off that much. 4.3% to be exact since Memorial Day weekend and almost all of that falloff has been in jet fuel. Gasoline demand is flat, even at $4/gallon. This type of environment does not support a sustained decrease in price, much to the chagrin of those betting on the banks.

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