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Sunday, 23 March 2008

Weekly Report 23 March 2008

The Collection Agency - Weekly Report

23rd March 2008

Welcome to the Weekly Report. Firstly a big thank you for the interest in this article. From the reaction I have seen, it looks like I put into print what many were thinking. Enough hindsight, let us see what opportunities and risks face us in the coming week, or longer. We take a look at the Financials, looking for weakness and strength, wonder what the Dow has to say and have a look at gold and a few other commodities. We finish with an example of current living standards in the US, thanks to an email sent to me a couple of weeks ago.

Regardless of whether we consider the Fed/US Gov't (Fannie and Freddie especially) intervention into "free" markets as right or wrong, we have to be realistic and face the fact that it is happening. One of the worst mistakes you can make as an investor or trader is to fight the Fed. Their pockets go much deeper than ours and as I have said previously intervention begets more intervention. Are we facing a dramatic drop in the stock markets, the big one? Or will the Fed/US Gov't instil enough confidence to let stocks rally?

It's the big question and it is one you do not want to ask. So rather than stand on the rail tracks hoping the train will switch rails, lets see if we can highlight some possible trends. Keep in mind the following, regardless of what the media and shills will tell you, the macro-economic fundamentals are under stress, meaning more shocks are likely. In the shorter term leverage is being unwound on some positions whilst new positions are being created elsewhere. Volatility abounds, it may give us new opportunities but it can also severely damage your wealth. Use protection to stop contamination.

First up an old favourite (that may not last….) Dollar/Yen/Euro/Dow. I use this chart to spot changes in Forex flows over the medium term. Some of my longer suffering readers know I use $/Y to help identify carry trade flows in stocks and bonds. Whilst the carry trade continues this chart will be helpful.

In this version, Yen is shown as a baseline (hence 0%) and the dollar (pink), DJIA (red) and Euro (green) show their respective moves from Yen.

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Click on image or here to visit the excellent interactive chart. You can change the baseline instrument by clicking the tabs at the top. Whose the daddy? The Yen, no doubt about it. Since June 07 even the almighty Euro has lost ground to the Yen, the damage to the dollar and dollar denominated Yen priced stocks is extraordinary. If you were a Japanese investor who bought stocks on the "dip" in August 07 you made a big mistake. If you sold Yen to buy dollar based assets, looking for the carry trade, you are crushed. Think of the charts you see pricing the Dow in gold, this is presenting the same scenario.

It gets worse, much worse. This next chart holds a warning about why policies that allow dollar devaluation will continue to damage fundamentals, we may be seeing an acceleration of foreign funds abandoning support for dollar assets.

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Again thanks to The two new lines are gold (turquoise) and the 10yr Treasury bond yield (pink) using Yen as the baseline. The one profitable carry trade, gold, has taken a big hit. Japanese/Yen borrowing investors must be wondering where they can get any return on the carry trade.

We are at a critical junction here, either direct Central Bank intervention stops Yen appreciation (remember Yen is up against just about everything) and restores stability or we could see a capitulation. With a lack of credit liquidity and therefore further leverage unavailable for Hedge Funds, Banks and Institutional Brokers, no wonder the Fed has spread its largesse this past week. If the carry trades in Financial Sector cannot add capital (margin calls) or double up, hoping for a reversal then they are stuffed, roasted alive.

So what will be the outcome? Let us look at this realistically, not at what should happen but at what the interventionist policy prone Central Banks are likely to do. We do not want to get caught on the wrong side of this.

As much as I would hate to see it on a macro-fundamental long term view because of the damage it will cause, I think Central Banks will intervene, they know of no other reaction. The only question open now, in my opinion, is the timing. Do the Central Bankers wait for the beginning of a capitulation move or do they move earlier to try and prevent it?

Looking at the timing the Fed took over Bear, they were deeply concerned about the Far East reaction (Greenspan was asked what would be the biggest change to his routine after he left the Fed, he replied "not having to check the Tokyo markets first thing in the morning") and ensured the plan was released before Far East markets sold off heavily (they bounced on the announcement). So we need to be prepared for an attempt to push the value of the Yen down, to re-invigorate the carry trade and stop Yen based losses. If such intervention does happen (I could be wrong, I have been before) the rally in stocks could be fast and large. As the Financials would benefit the most, I would expect them to rocket higher.

However, any such move may well be temporary. Remember, Banks, Institutions, Primary Dealers and through them Hedge Funds are surviving on the Feds willingness to lend. The Fed will want their money and assets back (with a profit, notice Fed lending is not free) and a rally could well be an opportune time to unwind positions, drawback leverage and withdraw credit facilities on repayment. Look for strong hands to sell into the weak hands who buy. Keep an eye on the financial media, if it starts telling investors that the good times are back, be wary.

Finally on the subject of Yen carry trades, I did a bit of digging, looking at $/Y and 3 month Treasury Bill yields. I went back to 1980 to encompass 4 recessions, mainly to see what effect recessions had on Fx rates and yields. I got more than I bargained for.

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$/Y is in blue, 3 month T-Bill rate in red. Some important points show up here. Falling yields weaken the dollar, rising yields strengthen it. Since the double dip recession in the early '80s there is a strong correlation to this link and showing that yield moves lead FX changes. We can see the effects of Japanese Central Bank interventionist policies from 2001-05 as the dollar was propped by the Bank of Japan which mitigated but did not break the correlation.

Now we shouldn't map the future according to the past, we avoid it wherever possible but Central Banks tend to rely on the past to give them lessons for the future. Let there be no doubt, either the Fed has to raise rates to stop $/Y descending into the abyss or the Bank of Japan has to intervene and prop the dollar by selling Yen.

What are the chances of Ben "chopper" Bernanke raising rates in the next 6 months?

Intervention from the Bank of Japan becomes the last hope of the carry traders, without it all of the emergency actions taken by the Fed will come to naught. I may not like the Feds policies or direction but I do not think they are stupid. It seems to me that the Fed has laid the foundations for the Bank of Japan to build upon.

So how can we ensure that if/when intervention occurs we are not standing in front of the train?

You do not want to be caught in short positions on dollar based shares as a re-invigorated carry trade will home in on perceived Yen priced value. If the dollar climbs against the Euro be careful going long on speculator dominated commodity positions. Whilst in the big scheme of things such actions by Central Banks can only be temporary, remember timescales are relative. A temporary move by Central banks can last 1-2 years, sometimes longer. That is far too long to attempt to fight the trend as a trader.

Here is my long term trend chart of the Dow:

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The trend is still down but we have an important attempt to hold the 2000 high as support. Note the retest of the moving average. It looks to me that over the next 2-3 weeks we may well get to find out if concerted, combined Central Bank intervention is to take place. You do not want to be on the wrong side of the move whichever way it goes from here.

Lets look at a few daily charts of financials both in the US and UK (The Bank of England, as reported by The Sunday Times, seems to have decided to use Fed style tactics to support Financial Institutions, although Merv King did say his remit did not stretch to "propping up the banks' profitability") remember, don't fight the trend.

Goldman Sachs:

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UK financials:


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There are other Financials worth watching too but I cannot discuss them.

Finally gold:

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I have a position but it's a hedge and therefore unaffected by whichever direction gold chooses to go.

A couple of weeks ago a reader sent me his thoughts on the current economic climate along with his personal experience and situation in life. Normally I wouldn't do this but I think it may strike a chord with many readers.

M***, a US veteran living in Oregon, didn't rant or ask for anything, he just wanted to show his frustration at seeing old mistakes from the past repeated in the present. Notice that M*** is not a spendthrift, he is solvent and responsible:

"The day before yesterday I tanked my truck up to the tune of $79.50 (I already had a quarter tank) and used my debit card by mistake rather than my credit card, easy enough to do since both are WaMu MasterCards. So, realizing that, I had to go yesterday to the bank to make a cash advance on my credit card to deposit into checking to make sure I did not have an NSF fee of $32. Like so many other Americans today, this is just how fine a line I tread in daily living though my gross income is now over $51K and I am single with no dependants, and I do not work but am a disabled vet who also gets social security disability. Thank god I only have a total of $1*K in debt for my truck and credit card and nothing else.

Well, since banking today is more or less an exercise in futility, yesterday was no exception. The bank has new rules and I was not allowed to take a cash advance from credit for deposit into checking, I had to go to a payday loan shark for the money to avoid the NSF fee. So maddening when I get paid on Wednesday anyway.

Frankly, I wonder how much longer WaMu can stay in business, I doubt it will be allowed to fail entirely, but more like folded into another bank, or carved up and sold off piecemeal for pennies on the dollar. You know last year in the summer I went to them to ask about a veteran's home loan when I was thinking of buying a condo, they told me they no longer do those loans. Loans mind you that are backed by the VA. Also, when Wachovia took out two truck payments last summer in one month and messed me up, then refused to make a refund of the overpayment I went to WaMu to refinance my vehicle there, I was told that no longer do any form of auto financing, I went through State Farm instead.

I am a prisoner of this system though, as a recipient of two federal benefit payments per month, each requiring direct deposit, I may find one day that I cannot access my income at all. I already feel like I am on the border of what is referred to as working poor income levels, that is income adequate to stave off real poverty, but not enough to live well or even buy a house. I got by better two years ago on the VA income alone than I do now on combined VA and SSA incomes though both have had small COLA's since. I estimate that more than one third of my purchasing power has been lost to inflation in the last 35 months since I moved to ******.

It is my opinion that the rest of America will do what I am doing, cutting back all but the very most necessary spending, I eat little meat anymore, and never go to restaurants, I even get haircuts only about every three or four months and then I just have it buzzed off. I refuse to pay $25 for a haircut with tip, and if McDonalds wishes to grant themselves an 11% across the menu raise when I cannot do likewise then they will have just lost my business (I remember when a great steak dinner out was cheaper than a big mac meal is now, and it was not THAT long ago).

I think few Americans under the age of 40 can remember just how painful stagflation is, in my county on the ***** coast in the seventies the unemployment rate was 30%, I faced graduation in 1976 with no prospects for either work or college. I had no choice but the military. They never called it a depression, but for much of America that is just what it was.

So, I economize to the maximum extent I can and buy silver with what I can scrape up each month. It is not a lot of metal, but it is infinitely more than 90% of Americans who have laid nothing real aside for harder times. Mr. Bush and his NeoConmen have looted the nation and the piper is coming up the footpath to our collective doors, they may never call it a depression but no matter what name they offer it will come faster and crush more than any of your readers will ever understand.

Thanks for letting me vent and thanks for your great work, keep it coming.


Thank you M***.

1 comment:

Anonymous said...

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