The Japanese tragedy continues to unfold and I, like the rest of you, watch on in horror. Meanwhile, the toxic sludge spewing from the traditional financial media outlets is at full throttle with spigots wide open.  Nothing like a good tragedy to create hysteria and boost ratings.

I’d like to take it down a notch and offer a reality check:

1) We don’t know what will unfold, hence a deep breath is required to make the correct financial decisions. Is it possible Japan will cease to exist as we know it? So many talking heads on TV breathlessly report this apocalyptic angle. I humbly suggest most of the supposed ‘experts’ are not experts in the field of nuclear fusion and are most certainly not experts regarding the fluid situation unfolding in Japan.

2) “But they are experts”, you want to say. After all, CNBC, etc., all laud their words and the string of letters after names (i.e. Ph.D., etc.) implies intelligence. Alas, perspicacity is not guaranteed with extra book learning. In fact, evidence suggests arrogance is the common illness acquired. I will remind you that so called ‘experts’ were trotted out during the Gulf oil spill last year and they were almost all invariably proven wrong.

3) Today, ‘experts’ say Japan sits on top of seven volcanoes and another like magnitude earthquake will surely swallow the country whole. Last May similar ‘experts’ assured us the blown drilling platform and pipe were just the beginning of a chain reaction that would create an enormous fissure in the Gulf of Mexico and subsequent tsunami. I’m still enjoying the beaches of Florida, what about you?

4) Today, ‘experts’ say cesium will undoubtedly billow out from the Fukushima site ruining arable land in Japan – and even in the U.S. if the winds are right. Can this tragedy happen? I assume so. I’m not taking the situation lightly but (and here is the key), I don’t know. What I do know is that so called ‘experts’ assured us that a methane bubble was going to explode in the Gulf of Mexico last year and rain down acid in the farm belt of this country. Reality: No acid, just quality rain that created bumper crops this past year.

5) Today, traditional media outlets as well as the blogosphere love to direct our attention to a view of an empty Tokyo street and a Geiger counter. We are implored to watch this scene closely for impending doom. Of course, last spring these same fear mongers beseeched us to watch endless hours of a subsea oil pipe spewing energy. I’m still trying to figure out how that energy footage was useful, so I can’t even begin to get to the Geiger counter, sorry.

Conclusion: Two months and five days after the BP oil explosion hit the news wire BP’s stock price bottomed at $26.83. One month later the stock price was up 45% and today the stock price sits about 65% off the low. I’m not suggesting the duration and returns will be the same in this case.  Certainly, events could unfold that will make this tragedy worse. In fact, one could argue this situation is already more dire and I would not disagree. The time for recovery could be longer. However, I am trying to add a little perspective. Financially remain calm and if the opportunity presents over the coming weeks, look to build a portfolio of companies that will benefit from the rebuild of Japan.

Precious Metals Outlook: Meanwhile, the precious metals (Gold and Silver) continue to offer the best harbor amidst the financial tempest.  Gold remains marginally higher in all currencies since the tragedy began last Friday. I would wager any decline in the metal price can be tied directly to the unwind of the Yen carry trade.

As the reader may recall, the Yen carry trade is a favorite of the leveraged fund manager. Said manager borrows Yen at extremely low interest rates and invests in other assets he feels will outperform the cost of the borrow. In a simple example, the manager invests borrowed Yen into Australian government bonds at an advantageous spread (let’s say he borrows at .25% and receives 5% clearing 4.75% on the investment if held for 12 months). He sells borrowed Yen, buys Aussi $s and buys Aussi bonds. The problem occurs when this overly crowded trade hits the speed bump of a rising Yen.  If the Yen rises in value too quickly this highly leveraged trade begins to lose money at an alarming rate as the cost to buy back the borrowed Yen exceeds the 4.75% annual spread.

The real world tsunami in Japan has created the financial tsunami described above. The leveraged carry trade manager has been forced to buy back Yen and unwind said trade due to the crisis. The Yen reached all time post WWII highs against the US$ yesterday. How long this unwind panic goes on is anyone’s guess, but this explains why on some days (like Tuesday) all asset prices go down together as margin requirements are being met and the carry is unwound.

For those of you needing encouragement to stay the course with your Gold and Silver holdings, Gary offers the following thoughts:

1) World gold production is approximately 2500 metric tons (mt)

2) 2010 production in China was 341 mt

3) Thus, world production excluding China equals about 2159 mt

4) Chinese central bank buys all internally produced gold; thus, imports are bought by Chinese citizens

5) 9.3% of estimated world production of 2159 mt in 2011 was imported for Chinese consumers through Feb or 55.8% annualized

6) World gold production was flat to down over last 3-4 years and not expected to grow in 2011

7) The Industrial and Commercial Bank of China Ltd. (ICBC) started physical-gold linked savings accounts in December. Account openings have surpassed 1 million, with already more than 12 tons of gold stored on behalf of investors. The ICBC has more than 20 million accounts. If the savings account program is introduced throughout China, Chinese demand could easily overwhelm world gold output.

Tags: Australian, Australian bonds, BP, carry trade, Cesium, chinese, CNBC, earthquake, Fukushima, gold, Gulf of Mexico, ICBC, Industrial and Commercial Bank of China, Japan, Methane, Oil Spill, precious metals, Precious Metals Outlook, silver, Tokyo, tsunami, Yen carry trade

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As usual European news leads the way with a ridiculous ’shoot in the foot’ decision coming out of Germany…

Merkel will announce, on Wednesday, a financial transactions tax, and a ban on naked short selling on 10 of the “most-important” financial institutions in Germany. Ban also applies to CDS and Euro govt bonds. Will remain in place for an indefinite period of time.

…Neighboring countries have not agreed to implement the same tactics.  Best guess, this ludicrous stance from Germany will only lead to confusion and have a negative effect on Bund prices as rates will rise. Moreover, as we learned in 2008, banning short selling in the shares of financial (FIN) institutions does not stop the decline in share value. In fact, as the record from 2008 reflects, said ban only serves to highlight the precarious position of the financial institutions and leads to more selling.

The idiocy of Merkel’s decision is mind numbing and only proves the current German administration has no understanding of how markets work. I haven’t the time nor the inclination to explain all to these neophytes but I will offer this simple insight: Short-sellers are natural buyers on the way down. They are short term position takers and as stocks drop they buy to cover. Preventing this behavior will obviously result in more erratic price movement.

Well done Merkel, you have succeeded in highlighting the weakest FINs and during a time of extreme volatility, you have accomplished the single worst feat: You have reduced liquidity!  For your actions, we award you with this ‘Larry Summers’ medal of honor.

I find the next news story much more disturbing. The passing of the Volcker rule would add to the cacophony of voices attacking the financial sector. In my last post I wrote, “Make no mistake, as the volume of negative news and behavior towards the FINs grows louder the equity markets will suffer.” The Volcker rule will act like a bullhorn. A quick glance at the price charts of leading FIN stocks will confirm that many in the group have already taken out the lows set during the 1000 point Dow sell off on May 6th. As expected the rest of the market is following….

FT Says Volcker Rule, Given Up For Dead, Is Likely To Pass

As the FT notes, “the political mood is such that a straight vote on derivatives would be close and the Volcker Rule would be likely to pass.” Should the Volcker Rule pass, this will be the beginning of the end for the current casino capitalism system that has gripped Wall Street. And don’t be surprised to see a 10% drop in the market as a last ditch self defense mechanism by the primary dealers.

Read More…

…The final story helps explain the particular negative action today.  Almost all markets are selling off today in unison; Dow, S&P, NASD, NYSE, Transports, Utilities, Commodities etc.. We saw this type of indiscriminant selling during 2008 and it was usually a sign of the carry trade unwinding and margin calls being met. Hard to tell what the markets will do from here. Sometimes this type of selling across the board helps set up at least a temporary bottom. Of course, this action could also lead to a repeat of May 6th or worse….

Carry Bloodbath Resumes With Full Blown Liquidations Imminent

After earlier we saw the decimation of the European currency, it is now Asia’s turn where an impressive bloodbath is now raging. The AUDUSD is in freefall, having moved a massive 300 pips from yesterday’s high to today’s low. At under 50 pips from 0.855, the AUDUSD will likely breach 0.85 at which point the destruction at carry desks will become an epidemic, and full liquidations will soon ensue, coupled with billion dollar margin calls, forcing global asset liquidations at bulge brackets. With the carry collapse pervasive, don’t look to futures to stage any miraculous Fed-inspired ramps tonight: Germany may have well called the Fed’s bluff.

Read More…

Tags: carry trade, CDS, commodities, euro, European, financial, Germany, volatility, volcker, Volcker Rule

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Stock Market Investing: The equity averages are down another 2.5+% today capping off an awful week during which time the uptrends from March and the 50day moving averages have been violated. The price action should not come as a shock but instead as a reminder of the tightrope the Fed must walk in order to keep this economic house of cards from collapsing.

The Fed’s quagmire: Use quantitative easing and other liquidity producing programs to save the U.S. economy from a depression while at the same time avoid turning the US$ into the North American equivalent of the Argentine Peso. (This method of saving the economy is a pet project of Ben Bernanke and the culmination of his years in academia, G-d help us. Never in history has the debasement of a currency led to a true and sustainable economic recovery. But I digress.)

So, in order to continue the debasement shell game, the Fed must occasionally make it look as if US$ strength is important. What better time to feign support than at the completion of a $300 billion Q.E. program and in the midst of positive GDP excitement. I have been writing for weeks that when we begin to read about “good” economic numbers we must take action to protect the portfolio. Well, this week was replete with “positive” numbers, so the US$ rallies and asset prices suffer.

Investment Strategy: Remain long a core position of precious metal investments and use inverse ETFs to benefit from market weakness. We expect precious metal investments to outperform on a relative basis and would view any weakness as opportunity. I will note: today the spot price for Gold is down only .15% as I write this; the epitome of relative out performance.

You may wish to know why I place quotes around words like, good and positive, when discussing the recent spat of economic numbers. Well, the answer is simple: when we and our respected colleagues parse the numbers warning signs are uncovered. Please review the following two accounts of the “exciting” GDP data so you can better understand our concerns…

Briefing: Q3 GDP Goes Positive!

As expected, GDP growth in Q3 went positive for the first time in four quarters. GDP performed better than expected as output grew by 3.5% quarter-over-quarter annualized compared with the consensus expectation of 3.2%. Demand was strong across all sectors of the economy as consumption increased 3.4%, gross private domestic investment increased 11.5%, exports increased 14.7%, imports increased 16.4%, and government expenditures rose 2.3%. With all sectors seemingly humming along in Q3, final sales of domestic product jumped 2.5% compared with an increase of only 0.7% in Q2…

Unfortunately, a more detailed look at where economic growth occurred makes it difficult to pronounce a full sustainable recovery is on its way. Government assistance played an extremely large role in producing the positive GDP result. For example, the Cash for Clunkers stimulus package boosted motor vehicle sales and contributed 1.47 percentage points out of the 2.36 percentage points that personal consumption added to GDP. Further, the first-time homebuyers tax break has benefited not only the construction firms, who have ended their decline in manufacturing new homes, but also realtors through increased income/fees. The jump in realtor expenses accounted for a full third of the increase in the residential investment component…

Inventories provided positive growth to GDP for the first time since Q3 2008. However, the data is a little misleading. GDP is measured as a rate of change between quarters. Inventories actually declined by $46.3 billion in Q3. However, the drop in Q2 was so severe that the rate of change was actually positive $29.4 billion. We expect inventories to continue to improve over the next year and provide a strong bonus to GDP.

GDP is…Better Than Expected: The Market Ticker

You cannot have an economic recovery when on a q/o/q basis real disposable income is contracting at a 7.4% annual rate and worse, the spread between nominal and real income is widening, indicating that mandatory purchases such a food, energy and health care – are increasing. MORE…

Meanwhile, Norway becomes the second country behind Australia to increase interest rates. The heat is being turned up on the carry trade and the Fed. This development out of Europe places further pressure on the Fed to ease up on Q.E….

Norway’s central bank hiked rates by a quarter-point to 1.5%, the first interest rate increase in Europe since the global financial crisis bit a year ago. It signaled more tightening to come as the economy recovers. Higher crude prices have helped oil-rich Norway. Commodity-rich Australia hiked rates earlier in Oct. The U.S., U.K. and euro zone are unlikely to hike rates soon.

Next week I will discuss the possible duration of this US$ rally as well as the Fed’s ability to remain hawkish. Until then chew on this…

A government big enough to give you everything you want, is strong enough to take everything you have. –Gerald Ford

Tags: carry trade, Fed, gold, investment strategy, precious metals, stock market investing, US$

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Well, apparently my conclusions are sound. Today the U.S.$ price is down more than 3/4% making a new low and news out of the UK is leading the charge. The Pound Sterling has gained 5% this week alone vs. the U.S.$. Today’s comments out of the BoE speak directly to the points I highlighted yesterday….

Pound up as BoE shows no asset-purchase split – WSJ
The Wall Street Journal reports sterling moved sharply higher after the Bank of England released the minutes of its October monetary policy meeting. In the minutes, it was clear that the decision to leave the scale of asset purchases on hold at 175 bln pounds was unanimous, relieving suspicions that some policymakers at the BoE had wanted a further boost.

The currency had already started the day with a positive tone, after BOE Governor Mervyn King warned consumers in an overnight speech in Edinburgh to be prepared for rising interest rates in future. That pushed the pound up from the $1.64 area at the outset of European trading hours. Now the October BOE minutes have added fuel to that move, shoving sterling well above $1.65. Sterling has recovered a good deal of lost ground of late after a recent drubbing. It has climbed by over 5% against the struggling U.S. dollar in the past week. The euro has sunk by a more modest 3% against the pound over the same period. Strength reflects a sense that the currency’s decline seen over the previous two months was overdone, prompting some bears to bail out of negative bets.

…Meanwhile, news out of the Fed here in the U.S. confirms the Fed’s commitment to lower rates for “an extended period.” This potent combination of diverging Central bank rate direction is the exact recipe for the lighter fluid I spoke of yesterday and the impact is felt immediately in the Forex market….

As this saga unfolds our investment strategy remains the same. Long precious metals and the commodity space. We would expect a continued equity market advance and would focus on investments in other countries where the currency and the growth rates outperform the USA. For a complete list of companies that we feel offer significant potential, please visit http://www.rosenthalcapital.com/ and view the Letters and Articles page.

My next post will cover three major issues I feel could derail this equity market rally. Until then remember, “It takes as much energy to wish as it does to plan.” Eleanor Roosevelt

…Of course, the reason Yellen can make the above comments stems from the ongoing USA real estate problem. In fact, today data released about mortgages continues to cause concern, “MBA Mortgage Applications -13.7% vs -1.8% Prior.”

I wrote in yesterday’s post, “The U.S. $ carry trade will gain steam if European economic recovery/inflation outpaces the U.S. and leads to rate increases”.

Tags: boe, carry trade, fed's yellen, investment strategy, mortgage applications, pound sterling, US$

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As the graph above illustrates, a serious correlation between the US$ and the US equity markets has developed over the last 9+ years. This correlation is strong and for policy makers in Washington, rather disturbing. The relationship is as follows: If the US$ loses value the equity markets have rallied and if the US$ strengthens equity markets have sold off.

A hint as to the future direction of the US equity markets may reside in the chart above. If this strong correlation continues than any insight into the future strength or weakness of the Greenback could be helpful when managing a U.S. equity portfolio.

To that end, I offer the following story about the relationship between the US$ and the Japanese Yen. The Japanese economy has for years (decades in fact) been the poster child for failed socialist economic policies and as a result their interest rates have been the lowest of any major country in an effort to stimulate growth. Unfortunately, the socialist policies have overwhelmed the fiscal stimulus and a stagnation has resulted.

This stagnation has led to a very profitable trade for hedge funds over the years called the Yen carry trade. Simply put: with rates in Japan so low, an investor could borrow Yen, sell the Yen to buy the currency of another nation and use the currency to buy that nation’s government debt. As long as interest rates in that other nation were higher than in Japan the investor could profit on the spread between the cost to borrow Yen (tiny) and interest paid on the other nation’s debt (larger than tiny). Of course, a side effect of this trade would be the strengthening of the other nation’s currency and a major bid for said nation’s debt.

I believe the story below could be the proverbial “straw” that breaks the back of the US$. The US$ is fighting to maintain support above the crucial 80 level and avoid selling off to the lows of early 2008. The battle is in the process of being lost as the US$ sits at the 78 level as of this writing.

As the story below explains, the US$ is now cheaper to borrow than the Yen. The implications of this reversal could be enormous:

• A major leg of support for the US$ in the form of carry traders has vanished
• A major leg of support for the US treasury markets in the form of carry traders has vanished
• Could the carry trade begin to work in the reverse? Borrow and sell US$ to buy another nation’s currency and debt? This action, of course, would add even more pressure to a falling US$

The US$ is already under attack on many different fronts from increased government spending to seemingly endless treasury debt offerings to the Feds decision to monetize said debt. Will the loss of the carry trade support – or worse, a new reverse carry trade – lead to the real collapse in the US$? Only time will tell, but all signs point to trouble for the Greenback. This trouble could result in further upside for the equity markets as inflation becomes a reality and investors flee cash for high growth assets and commodities.

Dollar is now cheaper to borrow than yen – WSJ
WSJ reports the dollar officially became cheaper to borrow than the conspicuously low-yielding yen for the first time in more than 16 years. That doesn’t bode well for the U.S. currency, some analysts said.

The dollar has long benefited from positive yield premiums, especially against the Japanese currency, but the prospect of the Federal Reserve keeping U.S. overnight interest rates essentially at zero until at least late next year has wiped out the dollar’s premium. That means less incentive for investors to park funds in dollar assets for the relative yield advantage, or “carry.”

Tags: AIG, carry trade, Dollar, financials, greenback, libor, momentum, short squeeze, yen

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