Planet Yelnick

Yves on the Trump Trade

We are at a critical junction in markets, and our favorite guest blogger Yves Lamoureux advises on the change of trend. He has made recent prescient calls in other markets too, such as Japan. Earlier this year he called a change in stocks, and predicted the current blow-off run to new highs. Here is his view on the bond market:

In nature, there are seasons. In the affairs of men, there are seasons. And seasons in finance? Mentioning cycles in markets hurts the fragile sensibilities of so-called objective investors, however.

A wise investor knows it is not wise to follow the herd. We have come across what we believe represents the crystallization of crowd consensus on interest rates. The cover of The Economist dated September 22 shows the Fed on a small legged horse with the headline “Living in a low-rate world.”

It caught our eye, having correctly presented our case of the next wave of a credit event on July 5 at the very top of the bond market

We maintain our view that coming bond losses will be brutal, and we timed the bottom of real rates on the 10-year to perfection late 2012 (see our appearance on Yahoo Finance on 22 January 2013). Consider this chart:

Fear not, stockholders, because this time the Fed will come to the rescue by buying shares, a prediction we put forth more than one year ago.

A few will remember our track record on these matters. One year before the Fed started buying bonds, we predicted that the Fed would do so. Our business is one of making correct predictions, not endorsements.One year ago we predicted a Trump win and to wit that he was going to be credited by jump starting the economy.

Hope you are following the big picture of debts accumulation.

It is all part of the big picture. Bonds are going to continue to tumble past 2020, like we said back in the interview with Jeff Macke. As you see, our work often has a big lead time. It is advantageous to big money managers who need time to adjust and prepare. We have been bullish on stocks for a long time. In essence we have been front-running the market waiting for that point in time when the Fed starts buying our stocks.

For regular readers, it’s been on our radar for a long time and just recently did the Fed say that buying stocks is in its toolbox.

The same was done on the bond front. One year earlier, our forecast of the Fed buying bonds was met with a yawn because we were alone in this view. We were long bonds and they rallied strongly while everyone was outrageously calling for coming high interest rates that did never materialized.When the Fed started buying bond with their operations it was easy to unload our bonds at much higher prices.

On to the more technical aspects of our work

Our view has been that from 2011 onward, there’s compressing fear regarding bonds in terms of sentiment. In other words, each price drop is met with less reaction as we move forward in time.

It is at odds with price and behavior that are always coincident.

The apex of such behavior merits the cover of The Economist, and the timing was perfect. Away we go!

Consensus seems to be surprised by the strength of the rise in interest rates, or inversely, the drop in bond prices. Most observers admit being caught off guard but will willingly offer the view that this is a bottom.

Unbelievable. We strongly dissent!

Note that from late 2012 up to today we have traced a perfect wave 1 and wave 2 in 10-year real rates. It appears we have begun the cycle of a wave 3.

For fans of wave talk, this represents the most dynamic of waves, and it will lead in our view to substantially higher rates coming in 10-year and 30-year bonds.

We had written in June of 2015 about the term premium and showed how abnormally compressed it was because of the intervention of central banks. You can hold down anything for long time, but when the uncoiling comes it is more devastating and equates to actually what is unfolding with bond prices.

Our attempt to describe what is going on is simple: the cost of money is going up, or to say it in another way, real rates are going up. We will not hide that we have been a staunch bull on the US dollar as one of the implications of rising rates.

Precious metals saw an echo bubble and have resumed their bear market.

Our Trump prediction did re-enforce the view of how things will continue to shape up: Main Street may finally see some economic gains at the expense of Wall Street!

Yves Lamoureux

@yveslamoureux

Yves Calls a Bond Panic

Bond rates have dropped, surprising the herd, which had expected a continued rise as the Fed tapers. Yves Lamoureux, the New Bond Guru, has put out a new report: Where are bonds headed for 2014. He expected, since February, the long bond to drop to 3.25% this summer before snapping back to higher rates. 

In 2012 Yves called the end of the 30 year bond bull market. He was called the New Bond Guru for calling it correctly while the Old Bond Guru (Bill Gross) was still predicting bonds to rise and rates to drop. A year later in August 2013, after a rise and rates and then a drop, he put out an important bond call that bond apathy was ending and a bond panic would set in as rates were to rise again. After a 30-year drop in rates, the long bond rose from around 2.5% to over 4% in less than two years, an astounding change that Yves predicted too. The ten-year bond rose from 1.6% to over 3%. Now rates are falling and a short-term panic (rush to buy) may push them further down.  

Yves commented to me that with all this money going around clueless, the next big trend he sees has nothing to do with Wall Street's current obsession about a slowdown and deflation. He sees a large reflation on the horizon that will surprise everyone again!

Predictions 2014

Predictions are hard. Especially about the future.  - Yogi Berra

1. Stocks rise to new highs, but peak in January or early February, and have the biggest drop since 2011.

2. Tech IPOs soar, and despite the correction, we have the best IPO market since 1999, but it won't be 1999 quite yet next year.  

3. Money begins to flow into VC again, as the depressed ten-year VC returns since the last bubble begin to give way to dramatic returns in this new tech boom

4. Gold falls below $1000 before reversing. This may coincide with the Q1 stock peak.

5. US ten-year Treasury yield goes over 4% before reversing. This may coincide with the Q1 stock peak. The correction gives a last chance to exit bonds, as rates drop again. 

6. After the correction, stocks rise, but the broader markets do not exceed the Q1 top in 2014. We will leave for Predictions 2015 if they have a secondary peak below the Q1 highs before sliding again. 

7. The Nasdaq runs higher counter-trend, pushed by a rational exuberant rotation into tech stocks. Will it hit 5000 again, last seen in 2000? I'll save that for Predictions  2015. (Why rational? It will be the only sector producing alpha in 2014, other than energy via fracking.)

8. Mexico is seen as the new Brazil as the BRICs hit a credit-crisis wall.  

9. Bitcoin fever breaks as governments clamp down. Is it the new Napster, or the new Tulip? Wait until 2015 to find out. 

10. The Republicans find a way to avoid self-destructing and capture Congress in 2014.

Yves Expects a Correction, Will Avoid Equities in 2014

Yves Lamoureux has been on a roll recently. He made a prescient China Top call in 2007 (reported here), then turned bullish early this year and says he is up 25%. In October he predicted stocks 'crashing up' (reported here) and they have. Now he has become cautious. His current view on the S&P is reposted below. But first, a few comments from him:

We find that the study of the yield curve has a powerful predictive ability. Where we disagree with most is on the size of the drop. Market opinion would have this ending wave drop in a C wave fashion. Drops of over 50% would therefore be possible. Our count view this pullback as a wave 2. The yield curve agrees with us on this matter.

 

Our tactical approach now is to avoid the S&P as we see it likely to turn out as being a big disappointment for returns in 2014.

Instead of US Equities, he is looking into emerging market equities. Also, he suggests now is the time for a short-term play back into gold. He sees a rise to $1500 before it falls back to his target of $1000 in 2014.  

Here is his reasoning on the S&P:

How often have you seen us get worried this year on stocks? Never! We held a courageous bull stance all year and never let go. This was taped in January with Jeff Macke.

This cannot be a permanent state of affairs. Many studies are pointing to risk ahead. We would prefer to leave some upsides to others. The best part about reducing risk is also pocketing handsome profits.

Conditions are quickly deteriorating. We did preview the chart of money velocities. It is falling to such an extent that we are shocked. Perhaps the uncertainty created by taper is to blame in part. We are asked about our view of bonds if stocks fall.

We mentioned in the past that this would become a nightmare for asset allocators. We believe in the positive synchronicity of both bonds and stocks to revert to an historic correlation. We think bondscan fall while stocks fall too.

The bond bear is really just at the onset. There is incredible damage ahead for people who have enjoyed bonds for decades. To them, there are no other alternatives certainly not stocks. They will suffer in the same way that stock holders did for a little bit more than the last decade. We had been over the same period very wary of stocks and had always preferred the safety of bonds. Oh my! How things change.

The rotation out of bonds to stocks will continue and remains the foundation of our strong bull market case in stocks to come. We think we are now providing investors ample time to re-balance portfolios accordingly. Now is the time to take some evasive action!

We understand that we cannot go to cash in a big way as clients will be less than delighted. Guess what? People who feared the market, now, want a bigger stock representation. We try to use our contacts intelligently to measure the pulse of investors. We think this represents applied behavioral studies at its best. We feel that this high is a perfect point to take money off the table.

We continue to be huge bulls on Asia. We think that the Shanghai market has begun a multi-year bull market. Our advise stands to rotate out of expensive markets like the S&P and go to emerging markets that now offer tremendous cheap values.

One of the really big mistake of retail investors is to feel comfortable with their own regional markets.

This will be a costly mistake for  years to come. As many emerging markets appear to go into the next stage of growth. They will also gain an exponential revaluation. They will go into bubble mode!

Yves Called Gold Right

Yves made a bold call on gold last February, well before the Fed's Taper Talk of May that spooked debt and currency markets.  Yesterday I posted his updated gold chart.  Let me show them side by side - you can see he called gold spot on.  

The Iran Deal Bear Trap

The Iranian nuclear deal may catch Oil and Gold investors in a Bear Trap. Initially it will be very negative for both - Oil and Gold should drop - as war fears had built a risk premium into these assets. When Oil gets and stays below $90 it should spook a lot of other markets by raising Liquidity issues. It is after that we may see a bear trap as bears pile on the dropping assets. This will, however, unfold slowly.

Yves Lamoureux sent a message to that effect, and will follow up with more specific recommendations. His chart on Gold shows the coming drop as a fifth wave down, indicating end of trend. He also expects it to show capitulation, necessary prior to a trend change.

 

Yves comment: "its become almost hilarious to see the market behave in extra slow motion; the fact that high frequency trades have taken over paradoxically leads to results in an extra time length as things actually unfold. The market with its speed has become stupid."

Yves on Stocks Crashing Up!

Our frequent guestposter Yves Lamoureux, president of Lamoureux & Company, a market advisory firm based on behavioral economics, has a view on stocks: up!  Neely sees the S&P in a final thrust up. The grinding climb of the Wall of Worry that has characterized this market since 2009 will continue until a final, panic-buying stage sets in. We may be now entering it. From Yves point of view, so what; a tumble in 2014 will simply set the stage for more appreciation downstream. Two competing lomg-term views that share a short-term prediction.  Enjoy Yves perspective. 

Crashing up!

Climbing a wall of worry at its best

 Vantage point:

 We are of course not surprised at the reaction of players who have missed the rally.

They will spew any and all reasons for this market to crash. Yes, it will eventually encounter a degree of such devastation that we would rather keep our timing to ourselves at that moment.

The gigantic money inflows was and is still the driver of this great move. There is more money on the way. It should be showing, as we have repeatedly explained, an exponential tendency.

We model interest rates for the next 15 years and believe that savings will never carry an explosive growth path of debts.

Forward looking the gap will only increase faster. This spread in turn will pressure bonds lower. It will wipe out a generation of bond only buyers or what we see as income oriented investors.

People argue that stocks will rise as the economy performs better. We are not of this school of thought. We object to much improvements going forward for developed markets.

Our behavioral work distinguishes between losing assets and winning ones by carefully tracking shifts in sentiment, which fundamental analysis disregards.

Being long the euro currency this year best exemplifies this kind of approach.

https://businessincanada.com/2013/10/23/lamoureux-to-loonie-look-out-below/

Two recent shocks over the last decade have profoundly shaped the perception of investors. This has forced a re-balancing of assets in favor of income. This is coming exactly at the heels of the greatest acceleration of debts worldwide.

I did use the word crushed in an appearance on Yahoo Finance to describe what was at stake for bond investors.

 http://finance.yahoo.com/blogs/breakout/beware-bonds-long-term-investors-crushed-says-lamoureux-122126464.html

We will not sugar coat our language when it comes to interest rates. We have tried to shock portfolio managers in presentations this year.

We can only describe the level of apathy we have seen as unbelievable. This is what a 30 year bull market will do to public opinion.

Our bullish stance has been validated this year with great returns.

We do suspect that we are heading for a rather tumultuous 2014. We think it is a bump in the road.

Our forecast for the Dow to double from next year's low point remains compelling.

http://video.foxbusiness.com/v/2103896522001/stocks-to-double-after-mild-pullback/

As long as the market climbs a wall of worry, we will climb profitably with it.

Yves

http://lamoureuxandco.com/

Yves on Gold - Update

Planet Yelnick got a good plug from The Wall Street Journal's MarketWatch over an analysis by our frequent guestposter Yves Lamoureux, president of Lamoureux & Company, a market advisory firm based on behavioral economics.  Yves has come back with a new update on gold. He made a prior prediction (in this blog) that turned out to be prescient.  Now he is back with a new update:

Yves on Gold  Update Part 2

We are amazed that a 2 months bounce can create so much attention on gold. We feel this is misplaced as oil is the asset that best gives out conditions of the macro environment. We suspect that few would entertain an Asian and European growth pick up at the same time. We do as we wrote recently.

All eyes have been focused on the economic negatives as the market demonstate a tendancy to go exponential more and more.

We think that the next few years will be terrific for stocks but these trends will be best explained as behavioral trends
 
Gold has perfectly set out to bounce in a typical corrective fashion. Any good Elliot Wave technician will know what to expect after an ABC bounce: new lows ahead.
 
After the big gold drop, as expected, targets were lowered to 1000 $. How convenient is it  to know this after the fact?
 
We kept you protected by issuing to avoid at all cost the metals early in the year and have stuck to our scenario all year. We knew that gold would bounce and be unruly after the analysts adjustements. So here it is with a 2 months bounce, the same behavior comes out of the woodwork as we suggested would happen.

In a certain sign of defiance talking heads are back claiming that gold will rally. We are sure to dissagree with this at this particular juncture.

We therefore forecast gold to head to 1000 $

Our proprietary model has flashed a third signal here and now. Both signals this year had preceded large drops.

We remain massive gold bulls long term. There will be no alternative to credit default in the future.

Yves

http://lamoureuxandco.com/

 

Yves: From Bond Apathy to Bond Panic

What to do after the interest rate spike?
This is a very important Guestpost from Yves Lamoureux:

From Bond Apathy To Panic
A harbinger of the next 5 years

Stock Bull

We have been glad this year to be on the side of the bull camp. Our job has been an easy one as we pursued the long side of stocks. We remain bullish despite raising big amounts of cash many weeks ago. We think we can redeploy money shortly once we feel the corrective phase is over.

It has been a much different story on the income side. One that shows only the start of something much bigger. We did forecast long bonds to drop to a yield of 2.5%.

For us that was the marker both in time and price that satisfied our interpretation of the end of the bond bull market.

It is our opinion that we are just in the first leg up in rates. Once completed we favor a correction that can last for a little less than a year. The second wave, we feel, will be as large as this recent move. This is why late last year we urged to look at a new asset allocation system based on credits only. We felt that rates would be at 3.5% mid year 2013 and a target of 4% year end 2013.

Our new forecast for 2014 on the long end now moves to 4.5%

We have had this scenario in mind for many years as past episodes rhyme in time. Our work is both based on comparative money velocities and behavioral economics. We tend to think that fear and greed are always the same. They tend to repeat more frequently than market theory allows us to believe.

Bond Apathy 

In recent presentations, we are amazed to observe the level of apathy toward the recent action of the bond market. It does match up behaviorally speaking with shock and the lack of preparation.

Investors have convinced themselves that rates are staying low for a prolonged amount of time. Of course this conviction will not be proved wrong rapidly. Over time, as we have suggested, money will leave the bond market to head to the safety of a term deposit at a bank.

Having been proved wrong twice about stocks makes the return back for most impossible. 

The great difficulty in this environment will be the lack of perceived safe alternative. It is also why midterm we are very bullish on gold even if we have avoided it all year long.

We think there are many pitfalls ahead that people will not avoid. We prefer to stick to being long indices as opposed to stock picking.

Rising rates will reveal the extent of debt levels. It first will be marked by companies cutting dividends. Bankruptcies will follow. It will be harder and harder to perform with the benchmarks.

Being long an index also has a positive survival bias. Bad stocks are replaced with good ones. The odds are in your favor with patience.

It is not the same say in the case of a bond fund. As rising rates will pressure your investments lower and lower. Doing nothing is sure to undermine your strategy and goals.

Dividend stocks are as much in a bubble as bonds are. We think its best to avoid income all together.

This will be a time of reflection. Some investors are not meant to be in the market. We expect a mass exodus of money that will be moving back to bank accounts.

Of course it is not what most in the financial business would like to hear. Markets are markets and they tend to behave in a certain predictable way.

The key to some of our future forecasts come from the inversion of the behavior in the treasury market.

We have been great believers in using treasuries as stock hedges in a portfolio.

We think this era is over as we have predicted well over a year ago. We are of the opinion that treasuries will revert to a positive correlation with stocks.

They will go up and down in price with stocks.

This is far from expected behavior of the last decade when treasuries rose in price when stocks fell.

Asset allocators welcome to your new playing field.

Emerging market implosion

We read with astonishment that deflation is over. The sudden drop in both emerging market currencies and stocks is testament to further aerial bombs we suggested would happen recently.

We are in complete disagreement over this topic as deflation shocks being short and fast creates lasting disinflation

The wipe outs are dramatic in many cases. Caught by surprise many have been.

Where people now see a bust credit cycle we see opportunity. The flow of hot money had created huge imbalances and a perception of superior fundamentals. The king is now naked.

We are taking a hard look at re-balancing our cash into some of those interesting emerging markets.

It reminds us of European markets that nobody   got interested in because of fear. Recent positives on Europe had us unload these plays at much higher prices than a few months ago.

Interesting times indeed!

Yves

http://lamoureuxandco.com/

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Aerial Bombs, Says Yves!

Guestpost from Yves Lamoureux:

We could not have been more ultra bullish on stocks since the start of the year. We are now concerned, as we had stated, of a fast unwind of leveraged positions. We have correctly called the bond and gold crash. That relationship is clearly evident.

Leverage worked perfectly when rates "WERE" low! They are not anymore. A quick survey would have yield getting to be twice of what they were at the lows. We had clearly defined our views of front running the bond market the other way around this time and it has avoided us this really big break.

What concerns investors avoiding stocks should have is simple. They are attempting to flee a stock correction by having invested in various bond investments. From high yields to corporates, everyone seemed to have the perfect solution to offer these stock refugees.

It will not have the desired effect. These investments will show the same correlation to the stock market. In a market correction they will feel a double blow. One from rising interest. The other from an economic slowdown.

On this subject, we have written extensively at the start of the year. We feel strongly about dividend stocks being in a bubble as much as bonds are. You can download our text dated December 19th that talks about these issues.

We have in our model a first clear danger sign of an economic slowdown in 2014. It can not surprise anyone that the back up in rates will filter itself through the economy and the housing market. This has been a recurring theme on our part.

The breakout of oil out of a triangle is an ominous sign as well. One that surprises us given the weakness in macro economic indicators. We are observers only and do not carry any oil positions. We certainly feel quite uncomfortable about a market that behaves outside of its normal supply demand equation.

Most participants have been taken aback by the fast rate rise. We certainly do not feel that the selling process is over.

When the quarter ends people receiving their statements will react to the drop. The slow crowd has yet to react!

The latest selling could in fact represents just the tip of the iceberg.

We view the Taper Talk as a huge monetary policy blunder. It has given the leveraged crowds a reason to rush for the exit.

Our beliefs still hold that rates were held too low for too long. It has given way to bizarre investment behaviour.

It will be resolved eventually as an implosion of cataclysmic proportions. More on this later. 

For now, we have decidedly pulled in our horns. The fast drop in value of bonds in effect counters a lot of the quantitative easing. A great win for bond vigilantes who apparently were non existent anymore and a resounding echo all the way to the land of the rising sun.

We will carry on with our own attacks shortly as we pass on to our subscribers our next moves. The target on the FTSE that we had set was reached perfectly. From the top, the drop appears to be in a five wave sequence. The recent rally a corrective bounce. It is quite worrisome to think about the next wave.

We are enthusiastic about gold forming a bottom in the near future. Our latest missive describes what we look for in creating a bottom. We also show why people have generally been wrong on evaluating gold metrics.

The second half looks promising but shows up also with plenty of potential hazards.

Yves

http://lamoureuxandco.com/

Yves Sees Forward to Gold Road to Salvation

As panic sets in, Yves Lamoureux is preparing his next bold call.  As reported here, he called the peak in gold before other pundits saw it, and made other bold calls that have him now referred to as the new bond and equities guru. Here is a copy of his Feb 8 newsletter on point: Download Lamoureux_Finally Why Gold Will Be Rigged Higher. 

His most recent views on economic conditions are summarized in this post from several weeks ago. We now have hit the inflection point he predicted. The reversal in bond rates is truly stunning:

The next phase of global volatilty is a surge of liquidity from a final central bank effort to prevent the reversal of rates and unwinding of all their efforts since the Global Financial Crisis of 2007. Yves expects this Financial Surge will float all boats, including gold. 

The pattern he saw in gold back in 2010 is now coming to an end, although not imminently. He recommending going long on the Euro and short on gold when the consensus was short Euro long gold. He remains a Euro bull for now, and will be super bullish on gold at the right time. Watch here for his guestblog when the time is nigh.  

Is Japan Signaling the Beginning of the End?

Since The Bernank spoke last week, the Japan markets have been in turmoil. Stocks have fallen over 12% in just a few days, and, most troubling, bond rates have risen sharply. See chart, courtesy Zerohedge:

Is the Bank of Japan losing control over rates? The theory of QE is that the central bank can manage rates down by purchasing bonds, but the bond vigilantes in Japan are pushing back.

In the US the fear is that the Fed will be unable to taper off QE. The Bernank's remarks last week were of a taper, and yet in the US the 10 year has spiked above 2%. There is a concern that if rates go above 2.2-2.25%, the biond portfolios will begin to rotate their mix of long and short bonds, essentially causing a spike in the ten-year which might shoot it to 2.5% - the so-called Bond Convexity. If this happens, expect the Fed to stop the taper and jump back in with (say) two months of QE in one month, to drive rates down. 

This would be quite a good buying opportunity of the ten year. It also may signal that even the Fed will face issues in trying to taper and avoid losing control over rates. 

GOLDENFREUDE: Gold as the Next Bitcoin

Amazing drop in gold this morning. First Bitcoin last week, now Gold. It hasn't declined this sharply since the prior all-time peak in 1980. One of the major goldbugs, Dennis Gartman, has written that in four decades of gold trading, he has never seen such a bloodbath.

Of course, if you follow this blog, you were well prepared, as Yves called this months ago.

It now is entering what Prechter calls free-fall territory, as it has has busted below a support level (first chart) and a technical level (second chart):

 

Goldenfreude is the pleasure of seeing goldbugs lose their shirts. A lot of prosaic punditry trying to explain this, and getting it worng. Most of the immediate selling was out of Asia, and was caused by Abenomics, the shock and awe of massive QE by the Bank of Japan. Buyers of Japanese bonds may have been leveraging their purchases by using gold as collateral, and now are liquidating to cover as the Japanese bonds plunge. The proximate cause for the two-day rush to the doors is likely Friday's China GDP report, showing a slowdown. Commodities are also taking a bath.  

This should not have been "unexpected", the common word used by mistaken punditry. We had two large gold sell-offs during the Great Recession, both driven by expectations of massive central bank intervention:

1) July 2008, right before the Lehman debacle and following on the heels of a parabolic blow off top in oil

2) September 2011, as the Euro crisis hit and central banks intervened

You cna see what the gold plunge is predicting: another bout of central bank intervention to keep the wheels from flying off the global ecopnomy. The first out of the blocks is the Bank of Japan's QE. The punditry expects the massive BOJ QE to respark inflation. Gold is signaling the opposite, of deflation.

Milton Friedman got the punditry thinking that inflation was due to the increase in base money (central bank money and reserves), but this is too simple:

1) The Quantity Theory of Money had inflation as based on quantity times velocity of money. Velocity has plummeted in the Great Recession to levels BELOW those of the Great Depression. 

2) Modern Monetary Theory has popularized the view that the quantity of money is not based much on base money, but on bank lending, as banks create the quantity of money. Put another way, banks do NOT lend out of reserves; they lend out of opportunity and then scramble to find reserves if needed.

The striking increase of bank reserves, and QE, have done little to spur bank lending; the reserves sit in the vault so to speak. Instead, QE has spurred excessive speculation in assets, what Minsky called the Ponzi Finance stage. Asset bubbles rage back and forth across commodities (oil! corn! coal! Bitcoins!), debt and margin are used to juice returns, and as each bubble collapses the velocity of money shrinks and the speculators fall back. 

Japan is now (as John Mauldin aptly puts it), a "bug in search of a windshield." Abenomics is leading to money washing back and forth across the globe, much as Hoover wrote in his memoirs about the sovereign debt crises of the 1930s. Is Cyprus the new CreditAnstalt?  This is not how a real recovery begins, but how a false recovery ends. 

Yves Calls Gold Spot On

Yves sends in an update on his gold call.  He said it would go down to $1450. It is now below $1500, down 20% from the peak, and is "officially" in a bear market:

Now to Yves update:

Our target of 1450 $ is in sight!

We have been bullish through a decade of bearish action on gold. We have equally been bullish over a decade of bullish action on gold. We have always been bullish through bull and bear market on gold.

We have learned to sidestep the market when desired. This sets us apart.

We adopted a neutral stance two years ago. It was meant to suggest a long pause and/or correction. This adjustment would be a combination of time and price.

We think players do not understand the length of the cycle. Our model suggest rising rates for 30 years.

It is with great excitement that we watch what is happening.

Gold is driven by the future perception of the US dollar. It is expected to go higher. Money managers have completely redeployed funds into the buck. They were substantially under invested at the start of the year.

We have a different view. We view the euro currency in a new bull market.

Gold bugs should stand up and listen ! You will get a weak US dollar in a coming future. The way you position yourself in light of events will be exciting.

Yves

http://lamoureuxandco.com/

Yves Goes Bullish on China Stocks

Yves has made some bold calls recently.  In 2007 he called the top in China stocks. Now he calls a bottom and says it is time to go long.  Here is his chart, and below his commentary:

We are now very bullish on Chinese shares. We called the top here in 2007. It was a few weeks before the market hit 6,000 on the Shanghai Index. The piece was called Party Like Its 1999. It focused on similarities that bubbles have. The rate of ascent was becoming parabolic and was unsustainable.

For most of the punditry, it was the Chinese miracle. I guess people never learn. Participants have the hardest of times to shake off their biases once in a bubble. 

I have been a witness to long term negative sentiment toward Chinese shares in the 2003-2004 period. I felt that the sequence had the hallmark of a final C wave. I got very excited in 2005. I felt very strong that the market was prepared to go up in a final 5th wave sequence. I was right. From a base level of around 1,000 the index proceeded to trade to 6,000 in a little bit over two years.

We did explain to our subscribers recently that there are great dislocations between the economic reality and the stock index behaviour. It is even more prevalent with the Shanghai market.

Years of impressive growth have never guaranteed a higher market. Why would it matter now?

The stocks have this uncanny ability to confuse most participants anyways.

We have held to our bearish stance since 2007 to only turn to the bull camp recently.

We are very bullish. We think that we are facing a wave 3 of 3. This large sequence could in fact propel the market back to its old highs. The market could double and even triple from here. 

We remember a time where Chinese funds were the rage. They are not anymore as they have lost their popularity. Long term sentiment is very negative toward China. We believe it is consistent with the psychology of a corrective wave two.

We think Asia has the upper hand in the debate of credits versus debits. Most of our work is derived from behavioural economics. We think it better lends itself to today's environment. 

Market observers are out of touch with today's world. Do yourself a favour to dig in the past as it is very revealing of our future. 

Yves Lamoureux http://lamoureuxandco.com/

Yves Makes A Bold Gold Call

Yves Lamoureux, our new Bond King, has made a series of bold calls around the end of the epic bond bull supercycle.  Besides being bullish on stocks, he now has a view on gold.  

Why Our Model Values Gold At $1450

We have watched the big wave one and two unfold in the bond market of Europe. We think we have seen the turn. It is therefore likely that a huge wave three in rates has begun in earnest.

It has been our contention that the interest rate cycle would turn in 2010. It did in Europe. We stuck to our 2.5% US long bond call has the recipient of scared money. Massive spikes are always deemed turning point. We explain this phenomenon in “The End Game is Here”.

We attach a lot more importance to what takes place in Europe. Our gold model is geared that way.

The recent behaviour of gold is the best proof. How can you account for a weak gold price when the US dollar is weak? We do cover the grounds on this topic in a recent gold article. Some of the intricacies of movements are popular trades being undone. 

The start of a wave three in rates sets up a deflation trap once again. Primary waves all sport typical 5 waves form. The corrective nature is mostly of a zigzag type. This is why we are short 10 years Italian Treasuries from 4.20%.A quick look at wave two is beautiful textbook Elliot. We are now at 4.62%.

The market thinks it has everything to do with politics. As you are a good student of waves, you know better. Keep the cycle in mind as we cover the gold valuation model. 

We thought that gold would top in September 2010. We think of this time spent as a large degree consolidation. We have not been at all worried to miss the bull market. We have fully participated in it the last 10 years. The recent bounce is more likely viewed as a B wave. I suspect, we are at the start of a C wave. I factor the coming rates increase. Our model values gold at $1450.

We look to make a big entry once again. We are extremely disciplined and wait for things to be aligned perfectly.

Yves Lamoureux, http://lamoureuxandco.com/

 

Buying AAPL: Catching a Falling Knife, or a Buying Opportunity?

By now it is clear Apple has fallen off a cliff after a parabolic rise.  History says the fall will at least retrace the parabolic rise. We saw this recently with Crude Oil rising over several years into a parabolical peak at $147 (cash price), then falling in six months to $31 before bottoming. We saw this in 2000 with a bunch of tech stocks, and in particular the leader at the time, Microsoft. Is AAPL, the leader in 2012, replicating MSFT, the leader in 2000?  The charts are eerily similar (courtesy Bespoke):

History also says a bull trap will emerge on the way down, a major bounce where many think they have caught the bottom, but when it reverses, they instead get sliced & diced as if grabbing a falling knife. Same bulltrap happened to crude on its rapid drop. The AAPL false bottom may have already occurred around $500 (see chart). After bouncing at that level, it has hit an airpocket and now seems on a bottomless journey down. A scan of the punditry finds some expectation for a bottom at $410, and I expect that level to catch some bids, but a look at the chart (red line) shows no support level until AAPL gets to the start of the parabolic spike up, at around $350.  

Apple is a quality company, and its recent miss seem to be more an anomaly of comparing a 14 week quarter a year ago with the 13 week quarter that recently ended than a sudden break in Apple's trajectory. Hence, at some point, a bottom will be found, and a buying opportunity discovered; the bigger question is whether, like Microsoft's lost decade, will Apple will grow quite strongly but never regain the recent stock highs? Maybe there is an app for that ... 

Green Energy Falls Off the CleanTech Cliff

This is really sad for those who believe in a future of green energy, but for investors has sent a clear message: the Green Bubble has burst. Solar City delayed their IPO, Solyndra and others are wrecks of a solar bubble, and Tesla may become the only electric car company standing as Fisker is now in deep financial trouble. The renewable energy stocks are down an astounding 98% from their peak, showing the signature of a parabolic rise into a bubble and a fast linear collapse:

BRICs-A-Bracked

The BRICs are a' breaking, with three of four sharply down and below their 200 DMA, indicating a trend change to a protracted bear market. Russia is now largely an oil-bearing State, and belies the trend down of the manufacturing States, but would follow if when the oil bubble echo breaks. From Bespoke:

This speaks to a shift from investing in emerging markets - a major theme of the past few years - back to developed markets. Emerging markets are down 3% in January, with India down over 10%, South Africa down 9%, Indonesia -7% and Brazil -4%. Inflation, arguably exported from the US be QE2, has thrown them all a curve ball.  

Demand Media Kicks Off Social IPO Season With a Bang

Amidst a nice little Obama SOTU Rally since late in yesterday's session, Demand Media (DMD) priced at $17, above the range, and is now trading around $23, a fine opening to Social OPO Season. DMD is now valued at $1.5B and is the largest Internet IPO since Google. The offering was also super-sized, from 7.5M shares to 8.9M. 

DMD has about the same market cap as the venerable New York Times. 

DMD has a different model than the NYT: it creates on-demand websites based on expected hot search keywords rather than create news stories based on, well, news. It covers topics that are of current interest, and should be compared to Time-Life or McGraw-Hill rather than a newspaper. This sites are a new form of the sort of special-interest magazines that McGraw-Hill used to cherish. Some of the most popular are ehow.com, livestrong.com, trails.com and the guy site cracked.com. 

A popular term in the websphere these days is "curation", the use of a human editor to organize and select content. DMD is a hybrid of machine-generated and curated, where the keywords help guide DMD to construct a site that matches how prospective readers are trying to find information on the web, and the human curators construct and update the site. In effect, they are using keywords to drive editorial content, and humans to make the site interesting. Although DMD is the subject of derision from old-fashioned editorial sites, it is better thought of as using modern, social techniques to determine suitable groupings of editorial content.

Its bet is the crowdsourced keyword editorial context drives better editorial content. So far its sites collectively are the 17th most watched sites on the Internet, an incredible achievement. The most read is ehow.com. 

If you wish to play this new category, a good read is this TradingIPOs analysis by Bill Simpson. He says to watch the operating expense ratio, essentially the spread between paying contributors and monetizing the sites. DMD uses freelancers for the most part. In an accounting decision which is controversial, DMD amortizes the cost of content over five years, rather than expensing; this turns a loss into a profit. He thinks fair value is $14-16, below the current trading range. 

The other issue to watch is Google's steps to rank search results differently, which could lower DMD sites in the search stack. Right now 41% of DMD readers come in from search results. The initial move of Google is to encourage searchers to report poor results, which I do not expect to lead to much of a response and therefore to have little impact on DMD. The war between quality results and synthetic sites from DMD will continue. 

The Social IPO Onslaught is About to Commence

The new wave of tech is the Social Mobile Web, and its leading companies are lining up to go public. We haven't seen such a lineup since 1995, when Netscape went out and rang the bell on the dot-com mania. Further back, this happened in 1980 when Apple went out (in an overall poor market climate) and set off the PC bubble. Will lightening strike a third time?

The first out is Demand Media (to be Nasdaq: DMD), run by Richard Rosenblatt, who had been CEO of the parent company to MySpace. DMD is a next generation style content site, which mass-produces sites based on hot keywords. Google search begats synthetic content, designed to rise to the top of search results and skim clicks.  Blogger Paul Kedrosky describes DMD's business as: “find some popular keywords that lead to traffic and transactions, wrap some anodyne and regularly-changing content around the keywords so Google doesn’t kick you out of search results, and watch the dollars roll in.” This modern way to produce content has produced hockey-stick growth, but Google just announced modifications to search results to undermine these synthetic web sites. DMD is highly dependent on search optimization and will quickly modify what it needs to to stay ahead of Google.

How this business dynamic plays out is anyone's guess.

How this IPO dynamic plays out will set a tone for the coming IPO Season. DMD should go out at over a $1B valuation, and be the largest Internet IPO since Google itself. It is supposed to price at the close on Tuesday (tonight) and begin trading Wed. 

On its heel are LinkedIn, Zynga, Groupon and eventually Facebook. LinkedIn is now trading at a $3B valuation. Yes, trading, even though it is not yet public. Markets fill gaps, and a secondary trading market for private shares has evolved for these social IPO candidates. Demand for these shares is hot hot hot, and Facebook ticked to a $70B valuation even as Goldman Sachs did an organized sale of $1.5B at a $50B value. 

You might wonder why they have to subject themselves to Sarbanes-Oxley and other nefarious regulatory schemes when they can raise and trade effortlessly in private markets. Well, the Empire eventually strikes back, and the SEC has put pressure on Facebook to go out as its tradeable shares close in on the 1934 Act limit of 500 shareholders.  

Until the Empire shuts it down, SecondMarket is a great resource. Here is its current hot list, showing which social IPOs should be hot:

Dogs of the Dow are the Cat's Meow

Bespoke highlights the Dogs of the Dow strategy - buying the 10 Dow stocks with the highest dividends at the start of each year. The Dogs outperformed the Dow in 2010 (so far) by 2x: 13% vs 6.6% for all 30 Dow stocks. The Dogs ran away from the other 20 Dow stocks, beating them by 4x: 13% to 3.4%. 

This is one of the simplest trading strategies, with one decision a year, even simpler than Sy Harding's seasonal pattern, with two decisions: buy in Oct/Nov when the MACD goes positive, and sell in Apr/May when it turns down. 

Here are the Dogs right now, for 2011.

Seems to me a real winner would be to combine the two: buy the Dogs in Nov to get the kickoff to the seasonal strong pattern. Any reader done the analysis? Please share. 

QE2 Sinks Munis - Time to Buy?

Muni bond investors felt that sinking feeling last week as their longer-term munis were swamped in the wake of QE2. "Munis in Trouble" headlined this jaw dropping chart of PIMCO's muni fund (courtesy The Big Picture):

A quick scan of the blogosphere will show boatloads of doom & gloom prognostication for the muni market. The collapse continued today and shows no sign of abating. Advisors are recommending an exit strategy, out of munis. 

Out here in the Left Coast of Cali-for-nia, the morning stories were about how the deficit is widening to over $25B, a number previously thought inconceivable. The exiting governator, Arnold Schwarzenegger, is trying to call a special session to deal with it, but the Democrat legislature would rather wait for the second coming of Jerry Brown. Maybe he can find a way to save their pensions and government salaries by cutting, well, what exactly? The Golden State has no defense budget to slash. Muni advisors look this way and see Greece. 

Yet munis are one of the few markets left with real investors, and only modest speculative interest. An attempt to turn the staid muni market into a feast for rapacious financial innovation fell apart during the past two years. The muni buyer may have heartburn but is unlikely to roll out quickly. The Muni ETFs are more likely to suffer as investors take to the lifeboats.

I own California munis, and think it will soon be time to buy more. Let me lay out my four reasons:

1. Seasonal factors are softening rates
2. Buying interest remains strong
3. Munis trade on technicals, and track Treasury changes most closely
4. Fundamentals are trickier than normal but do not presage defaults

Big Bond Bubble Beckons Bears, Buries Treasuries, And Busts Fixed Income Investors

Back in March, Barron's ran The Case For Bonds, poo-pooing a spate of articles back then on a bond bubble. The expectations were that the ending of Quantitative Easing (QE) would lead to a rise in rates. As we know now, didn't happen. 

What did happen was the Euro debt crisis drove money to safer havens in Treasuries, and the pronouncement of a continuation of QE led observers to expect a bigger QE2 ahead. Bonds soared as rates dropped. In the last few weeks, however, we have seen them reverse dramatically (chart from StockTiming):

 

Marty Chenard (of StockTiming) notes how the 30-yr has come back to a recent resistance level at 38.34 (see chart), suggesting a break will lead to a bond bust of very broad proportions. The bust is already being felt. Monday's WSJ will report how the last ten days have shaved 2.5% off the 10-yr, a sharp drop after a five month stunning rise. Bespoke noted late last week how the drop in bonds was already being felt in bond funds, and had raised the spectre of a breakdown in fixed income:

More ominously, the 10-yr has has not broke above the five-month trendline, an indication (if it doesn't reverse quickly) of a change of trend for a considerable period:
  
 

Credit for an auspicious call goes to Jeremy Siegel in the WSJ, whose op-ed The Great american Bond Bubble published on August 18, right as the trend reversal was starting. He noted how a reversal from the 2.8% rate then to the 4% rate of a mere five months ago would cause a capital loss 3x worse than the low yield. This led to a new spate of Bond Bubble articles. An update is here. 

An even earlier call came from ZH, which noted that global industrial production got back to pre-recession levels, and drew the implication that a Global Bond Hiccup was soon to come:

 

Before the bears celebrate, they should ponder what changed: expectations of the double-dip abated around the time the bond yields bottomed. If you have been following my posts on the Double Dip Countdown, I put the count on hold in early August, started it again around August 18, and have it on hold again - reflecting ambiguous economic signals. This has two big implications for rates:

• a flat patch would cause the Fed to hold off QE2, which suppresses rates
• a real recovery would cause market rates to rise, and the Fed to follow

Now fixed income investors face a dilemma: if the recovery is on, rates will rise; but if this is a mere blip before negative double-dip news begins to come back, rates will fall back. Should they stay (in bonds) or should they go? 

I will comment separately on munis in a later post, bit as to Treasuries, these are the circumstances where technical analysis may give better advice than struggling with conflicting and ambiguous fundamentals. Friday's STU has a wave count which is pretty daunting: the recent low rates reflect a 62% retracement from the low rates in 2008 to the recent highs in April. This suggest rates are going to continue to rise. Right now the technical indicator to watch is a definitive break of the trendline (see chart above). 

Does the 1938 Analogy Indicate Bonds Are Topping?

I have posted a series of analogies in stocks to 1937-8 and more recently to 2008. These analogies are interesting although not predictive unless the underlying conditions are creating a similar investor psychology. The 1937 analogy seems particularly apt because a change in fiscal policy - a withdrawal of stimulus - seems to have caused a double-dip. (It certainly caused a roller-coaster of endless academic debate.) The greatest Keynesian Cheerleader of them all, Paul Krugman, is now analogizing our policy environment to 1938. 

We still seem inside those analogies in stocks. The 1937 picture would have predicted a drop off the August high (we got it) followed by a rebound that stalls below the August high (we are in the rebound, do not know where it will go). The 2008 analogy says after the August drop we come back to retest the August highs, then fall off a cliff. Both have a few weeks to go before they really get tested.

I am now seeing a similar analogy game applied to bonds, specifically Treasuries. PragCap compares our current rates to those in the 1930s, and speculates that we are coming soon to the end of rate drops:

 

The question is why will the Fed raise rates, especially after the recent public comments about QE2?  EWI continues to argue (convincingly) that the Fed responds to changes in market rates, rather than drives them. 

 

PragCap goes on to answer the question they raised, and the answer is consistent with the EWI perspective: rates will flatline when the recovery commences, since demand for borrowing will cause market rates to turn back up. The analysis is also why low rates are not inflationary, since they have not led to increased lending (or borrowing); only a recovery will do that. 

Yet how close are we too a recovery and thereby a top in bonds (and a bottom in rates)? You can read my countdown to the double dip in prior posts, in which I conclude that we are unlikely to dip until 2011. Even now the signals are still ambiguous. 

Instead of an imminent top, bonds have more to rise. R&B Capital put out a report on a massive decline in yields that got a lot of play. Barry Ritzholtz picks up this theme, and provides this chart showing that 20-yr government bonds are high compared with benchmark interbank rates in both the US and UK:  

 

The implication is that the mid- to long- end of the yield curve has room to keep dropping. 

Yet we have had a really strong rise in bonds over the past few months, the type of race to a category that ends badly, or least is likely to correct rather than continue. When you compare stocks to bonds over the past decade, bonds can be argued to be approaching a blow-of top of the sort stocks hit in 2000:

  

That correction may have started. 
 

The Flight to Bonds Continues Amidst Deteriorating Economic Forecasts

Bond yields are approaching the historic lows of 2009 during the flight to quality. The rapid drop in the 10 yr in the absence of the 2008 banking crisis is truly historic. Since the April high in stocks all the mid-term Treasuries have raced down in yields (chart from EWTrends):

We may be approaching the end of a 30 year bond bull market, from the highs of 1980s to the potential lows of 2010. This chart from SeekingAlpha shows the trend:

The author raises the caution flag that a protectionist movement may be near. Seems a bit alarmist, but the Chinese currency, which began its float again to great fanfare, has now dropped for five straight days and is lower than it was then!  Congress is now, once again, raising the spectre of retaliation. 

A more prosaic explanation for the rush to bonds is a rise in fear, fear not of another banking crisis but of an economy rolling over again, this time (the fear story goes) with no weapons left to restart it. 

GDP forecasts are being slashed. Goldman joins JP Morgan and Deutsche bank in lowering the coming Q2 revision to the low 1% range, and increasing double-dip odds to 25-30%. Looking forward, ZH reports that a "Philly Fed" forecaster sees Q3 dropping from expected 3.3% to 2.3%, and slower growth in 2011 and 2012. Chances of a negative Q4 are rising. Please refer to the charts in the ZH link for details. 

Japan's GDP came in worse than expected, and led to a plethora of stories of how China has now overtaken it to become the world's second largest economy. Well, not quite, but perhaps by the end of the year. Europe's leading indicators have also rolled over, signaling a coming slowdown. 

The normally bullish Califia Beach Pundit reports that container traffic out of LA is showing signs of a slowdown even as imports are surging. (See first chart below.) While they see that import surge as positive, it may be due to elevated expectations of holiday shopping, expectations that are not being met. There have been a flurry of news stories of how retail is slowing and the dismal back-to-school sales are (they hope) merely delayed. The govt report can be downloaded here. 

 

Another poor sign is the rolling over of semiconductor sales based on a leading indicator. Since gadgets have been doing well, this is an ominous sign. 

 

Given the low rates, corporations are jumping into the bond market. Even junk bonds issuances are increasing as investors scramble for yield. This suggests that all is not fear. Corporations are said to sit on record cash, giving junk bonds a allure of relative safety. 

The question for investors is why buy at these low rates? There is less reason for a flight to quality today than two years ago. 

The wave pattern strongly points to a bottom coming in bonds, and then a bounce (in yields). The Monday STU notes that the gap up in the morning may be an exhaustion gap. Bullish sentiment towards Treasuries is now 98%, approaching the incredible 99% on Dec 16, 2008, right before the all-time high. 

One play is to buy the 30-yr. The recent Fed "QN" announcement targets the 2-10 yr Treasuries, which have dropped the most. The 30-yr may follow. The argument that inflationary expectations are keeping the 30-yr high are likely missing the dynamic that the Fed's intervention is driving the mid-term rates lower. Right now being long the 10 and short the 30 is a likely arb play that may be keeping the 30 yr lower (higher yields). On the other hand, the intervention of the Fed has paradoxically made the 30 yr less sensitive to interest rate changes than the shorter term instruments. Hence the 30 yr may not move if inflation kicks in, while the 10 yr will move more if deflation kicks in. 

Corporate bonds should also be looked at cautiously. The widely held belief that corporations are sitting on hoards of cash needs to be tempered by the even larger hordes of debt they hold. Just as corporate cash is at an all time high, so is corporate debt: $2.6T of cash but $7T of debt. 

Muni Bond Update

The state of Muni's matters to a lot of investors. I have argued in Investing in Munis that the States will be loathe to damage their ability to go to the Muni market, so will cut everything else they can first before defaulting or delaying payment. That argument passed its first test in the last few days. 

July starts a new fiscal year for most State governments, and some of them (Ill, Cal, NY) are in dire straits with huge deficits, ebbing Federal stimulus, and disappointing tax revenues. Bloomberg reports that they are cutting pay and letting bills go unpaid to protect their Munis:

"States have taken all measures so far to make sure they keep capital markets open by honoring their debt payments,” said Richard Ciccarone, a managing director for McDonnell Investment Management LLC in Oak Brook, Illinois, which owns $7 billion of municipal bonds. “They are doing everything they can.” 

The story repeats the comforting history of Muni defaults: at 0.03%, much less than similar corporate bonds at 0.97%. Most Muni defaults have not been general obligation bonds, but bonds tied to specific projects. Hence investors in Munis need to read through to the party really at risk; a special industrial district, hospital or similar project is much riskier than the State itself.

The CDS spread between Munis and similar corporate bonds has been higher for Munis, which might seem odd given the default history above, but it reflects the differing positions: US corporations are sitting on record cash, and their bonds are one of the safe harbors right now, while States are in deep deficit for the most part. The good news for Munis is the spread is narrowing as the fears of Muni default begin to ebb.  

Fallout From the Tesla IPO: Investing in Advanced Batteries

Tesla had a warm welcome at its IPO with a 40% first day jump and a 60% run to over $30 from opening at $19, but has since given back most of the after-market gain to close back at just above $19. This pattern is eerily like the IPO of A123 (AONE) a lithium-ion battery maker for electric vehicles: a first day pop then a drop. AONE continued to fall in a long slide to 35% below the offering price six months out. Tesla's trajectory created a "very ugly" inverted hammer candlestick at the top, which denotes a legion of quick flippers speculating rather than long-term holders. Tesla priced at $17 but opened at $19, where it garnered a lot of buying interest. It may find support there; if it breaks below, it could be dumped. 

Goldman Sachs helped underwrite the Tesla offering, and about the time of the IPO, launched a research report on lithium-ion battery companies which had a Neutral rating to reflect "a multi-year waiting period prior to clarity on plug-in hybrid and electric vehicle mainstream market adoption." Their main observation is that these advanced battery stocks are no longer trading on news but the market is awaiting proof points. Even this relatively cautious research report was found to be too optimistic due to expecting a too-steep drop in advanced battery costs due to economies of scale and a race by Asian makers to strive for share over margin. 

Let me be the optimistic here. We saw the sort of price drops Goldman expects (if not even steeper) in DRAMs and LCDs due to massive investment in Korea, Japan and China in scale manufacturing facilities. We also see rapid innovation emerging - for example, an apparent breakthrough in quick charging of these batteries: three minutes to 50% charge, about the time at the gas pump, or five minutes to 70%. Gas stations could add this as a new type of pump - and the price will be a lot lower per mile traveled. 

For Tesla investors, the Goldman report has a message: the premium in cleantech stocks seems to be gone, and now these companies will trade on results. Whether Tesla can remain above $19 is a good test of Goldman's thesis. Even so, if the stock decays as flippers abandon it, it should then find a strong bottom as A123 seems to have. At that point this becomes a bit of a long slog, but one with upside. Tesla as a business will grow in the near-term on technology deals with partners like Mercedes and Toyota, and in the longer term on getting its new S line out in 2012. 

Are Munis Next?

Warren Buffett is all warns of a "terrible problem" of municpal bond defaults as signaled by increasing credit default swap (CDS) spreads. With all due respect to Warren, his worries over the rising CDS spreads in California and Illinois bonds, however, are misplaced. Illinois is in deep trouble, but it is not the next Greece, nor is California about to join Club Med. The Big Picture does a nice treatment on why muni's are not in as much risk as sovereign debt despite scary charts like this one: 

 

Simply put, a State cannot go bankrupt. They can run out of money, as California is wont to do every year, but then they scale back their commitments: first education (50% of budget), then interest on muni's (7%), using California numbers. The shortfall has to be 43% before California muni's get at risk of default. Also, they simply cannot let their State debt go down. Individual cities or districts can, but the State cannot survive without debt. It needs the debt to bridge across sporadic tax collections. I discuss this at length in my longer post, Investing in Munis.

The muni rating agency Fitch recently re-calibrated their ratings, increasing them. As the WSJ reports, Fitch took into consideration the fact that many municipalities are under intense stress, but “historically, the level of [muni] default was very minute as compared to other sectors.” Investors have basically shrugged off the risks, as yields have not moved much in the face of rising CDS spreads (see chart, courtesy WSJ).

To top it off, the Stimulus has provided a large bridge to the States: $135B of the $150B estimated State shortfall will be covered by Stimulus. A lot remains to be drawn down, particularly for education, giving the debt service segment even more leeway. See next chart. Instead of dragging down muni's, State problems will drag down the Federal taxpayer. 

It seems inevitable that Greece and other PIIGS in Poo will default. It turns out sovereign nations tend to default much more frequently than muni's. They have armies and can get away with it. Here is what I wrote as the Greek Tragedy began to erupt and gold began to be hoarded:

What happens when the debts of the issuer are vastly beyond their productive capacity? Well, the country defaults, and the fiat currency is forcibly exchanged for scratch. A 2008 paper by Harvard Professor Rogoff and Prof. Reinhart, both members of the NBER (which calls recessions and recoveries) entitled This Time Is Different demonstrates that instead of fiat regimes making good, they have defaulted over and over throughout eight centuries of financial crises:

We find that serial default [repeated sovereign default] is nearly a universal phenomenon as countries struggle to transform themselves from emerging markets to advanced economies. 

Before we take comfort in the US being already an advanced economy, the imperial power of its day has typically defaulted after over-extending. Rich European countries have defaulted, including Austria, France, Portugal Spain and Germany. The reunified German defaulted in 1873, bringing the whole world into a long depression, including the United States. In the last century, Germany defaulted twice: 1932 and 1939. Russia three times, beginning in 1918. England in effect defaulted in 1931. 

The interesting conclusion: Treasuries, gold and Muni's stack up as the safer places to be. Even corporate debt from quality issuers may prove safer than sovereign debt. 

Corporate Bonds: The Next Safe Haven?

In the New Normal of low interest rates and low returns, institutional investors engage in a Global Scramble for Yield which makes them stretch for a few extra basis points, often assuming a disproportionate level of risk, as we all found out since 2007. Now we see a whipsaw market, which bounces between a jump back into risk or a Global Scramble for Safety, such as the run on gold coins that infected Europe after the Flash Crash. When the obvious safe havens get driven up, such as Gold, Treasuries and even cash (Dollars); and the hoped-for safe havens get their day, such as Munis; where to put the marginal safe investment? Jennifer Gordon of ForexIndicators.net (not .com) weighs in with high quality corporate bonds as the next place to catch before the scramble for safety drives rates down here, too - but with an eye to the exit! 

This is a possible safe harbor not well covered in the punditsphere, so your comments are encouraged. 

Fallout From The Crash: Gold

Gold is a hedge against bad government, not just inflation - Martin Armstrong

The biggest winner from the crash is gold, which has shot up, especially priced in Euros. The wolfpack of shorts continues to push down the Euro, rushing through the $1.25 level  to the $1.23 territory, rapidly submarining the Euro-TARP. It may be that the Euro is already headed for the trash heap of history. 

Or maybe not so fast. The net non-commercial short positions are at record levels. If the ECB is all-in, so are the shorts. I expect a big rescue mission this weekend, to try to squeeze the shorts. 

As wolfpack warfare wages on, the question is whether gold is in a parabolic blow-off top, which says get out, or is signaling the collapse of paper currencies is closer than we think, which says to protect capital at all costs. 

After persuing the pundits, my take is a near-term top which could be followed by further gold upside, but not right away. First those currencies need to crumble! The uncertainty is how close the top is. Let me walk through fundamentals, technicals and monetary economics. 

Monetary Economics

The gold spike engenders the knee-jerk reaction of impending inflation, but the money supply indicators are plummeting right now (chart courtesy Pierre du Plessis). Europe is actually contracting (below zero in the chart) whereas the US is growing money very slowly. 

With such a drop in money, it is no surprise that EuroZone GDP is flat, and may be about to fall into a double-dip. Given that velocity of money is also down, this is deflationary, and with the Fed having ended its QE program, unlikely to change. 

 

Normally such a deflationary environment is bearish for gold. To understand where gold may go, it is important to step back and reconsider the Quantity Theory of Money (QTM). Bear with me as I summarize the hyperinflation vs. deflation debate. 

Hyperinflation: I tend to skip the frenetic goldbug sites imploring you to buy gold, so I missed this Hyperinflation Watch piece by one of the leading proponents of a return to real money (gold). It came out just before the Apr26 peak, and noted how the money supply in the US was doing something that has seldom happened: it was shrinking. 

Rather than see the coming deflation, the author (James Turk) creates a new moniker, the Haverstein Moment, named after the ill-fated Reichsbank President who caused the Weimar hyperinflation of the 1920s. He is claiming inflation is running faster than money growth:

The so-called “shrinking” money supply that arises when adjusting for the loss of purchasing power from inflation is a characteristic portending imminent hyperinflation 

Deflation: I do however pay attention to the writings of Prof. Fekete, who has gone deeper into money matters and gold than anyone since Murray Rothbard, the Austrian economist, in the '60s. He finds the Haverstein Moment "grotesquely unrealistic" in a cogent discussion of the hyperinflation/deflation debate. The Wiemar Republic was the post-war Germany after WWI, with a Reichsmark no one wanted and a devastated capital plant. How to compare that with the US today, between a beggar and an emperor? The value of a currency is fundamentally based on the productive capacity of the issuer, and when capital gets destroyed the currency must fall until the capital is rebuilt (or the money supply shrunk). Fekete's point is absent a wholesale destruction of US production, a shrinking money supply and reduced velocity is a harbinger of deflation. 

He offers an alternative theory, the Black Hole of Zero Interest:

When the Federal Reserve (the Fed) is pushing the rate of interest down to zero (insofar as it needs pushing), wholesale destruction of capital is taking place unobtrusively but none the less effectively. Deflation is the measure of wealth in the process of self-destruction -- wealth gone for good. The Fed is pouring oil on the fire as it is trying to push long-term rates down after it has succeeded in pushing short term rates to zero. It merely makes more wealth self-destruct, and it makes the pull of the Black Hole irresistible.

Velocity. What money-supply watchers always seem to overlook is the velocity of money, how fast it turns over:

• Velocity decreases when deflation looms, as people hoard money (save, pay down debt, spend less)
• Velocity increases when inflation looms, as people trade it for tangible things (they spend it as fast as they get it)

When you look at the Weimar hyperinflation, and other incidents (Austria at the same time, Hungary in 1946, Argentina so many times), what you see is inflation is much higher than growth in money. This means velocity went up faster than the money supply. If people expect the Riechsmarks they get in the morning to be worth half as much by evening, they pile it in shopping carts and rush to the stores. THAT creates hyperinflation.

Nothing of the sort is happening right now. Verdict: gold should drop. 

Fundamentals

I would put this economics debate more prosaically as: we have barely begun the process of debt write-off and de-leveraging. That process will rapidly reduce the money supply, since in a fiat currency regime, credit creates money (debt becomes purchasing power and turns into bank accounts somewhere). Imagine what happens if the Euro-TARP fails to prevent the defaulting of Greek (and Portugal, etc). The debt gets written off and money is destroyed despite the attempts to keep the game going. As Fekete puts it:

Charles Ponzi's dream has come true. The US Government is duplicating Ponzi's scheme in the bond market

The magnitude of the Ponziness can be seen in a chart of equities adjusted for gold: 

 

If deflation is on us, gold will drop, as the Dollar (and Euro) will rise. If the Euro-TARP fails, the Euro will drop and rapidly bottom; the changed expectations of the coming debt destruction will then cause its value to rise. Oil has already rolled over, and so gold may soon, too. It would indicate an expectation that the wolfpack of shorts will outlast the ECB. 

So: gold tops near where the Euro bottoms, after the wolfpack wins. 

When might that be? It took the Austrian government a month to fail when they supported the Creditanstalt Bank in May 1931. While stocks seem to be unfolding this time around about 1/3 the pace of 1929-31, at the rate the Euro is sliding the endgame may be only a matter of weeks. The Euro has gone all in with a poor hand, and the wolves are ripping apart the pretense that more debt can solve an insolvency problem. 

If Europe fails to mass an intervention by Monday, the game may already be over, and gold will have topped.

Technicals

Even though gold seems to be spiking, we have not yet seen the sort of piling on that signals the endgame of a mania, indicating it could still run beyond sense. Indeed, while investors are feeling the gold train has left the station, sentiment continues to indicate otherwise. Gold may longer be cheap, but it may not yet be in a bubble: Cramer hasn't touted it yet! 

The Casey Report provides this chart of technical indications in the XAU, which show no near-term top (a much larger version is at this link):

 

This morning David Rosenberg also weighed in on gold, with this chart showing that we are not yet in a parabolic blowoff. He notes that if central bank reserves were backed by gold, it would be at $3000/oz. (Some pundits have estimated that to back all currency in circulation, it would need to be $15K/oz, but that is not required under a gold standard.) Believe it or not, Rosenberg now thinks "$3000 an ounce on gold may yet prove to be a conservative forecast." 

 

A comparison of where gold could go to recent history from yesterday's NYT gives several price points:

• $2400/oz based on the 1980 peak adjusted for CPI
• $5300/oz based on the 1980 peak adjusted for GDP growth (6x)
• $5700/oz based on expansion of M3 (up 10x) over increased gold stock (1.5x)
• $3100/oz based on expansion of M1

I don't play gold, so I leave the calls to the pundits who do. EWI have been gold bears for a while, and their predictions have lost some credibility due to their Wolf! Wolf! premature calls of a gold top. The STU tonight however is quite convincing on gold: bullishness is at all-time records at 98%, which is such an extreme it has marked tops in the past in silver, currencies, bonds and equities. They say they will have more on this next week. 

When everyone is on one side of a trade, the money is made on the other.

EvilSpeculator has a crisp recommendation, artfully put, to get out. Read how they put it! Neely had been recommending loading up, but after the recent spike, says to stand back for now and be prepared to buy the next big dip. Walter Murphy has identified a pattern in the Yen/Gold charts which gives him a 25% upside target that is well-defined.

Maybe the smart move is to buy a dip on a modest or slow slide, but stand aside if instead we have the type of fall we saw in oil in Jul08: a falling knife, signaling the end of the parabolic rise. 

Fallout From The Crash: Carry Trade and the AUD

An explanation for the crash that is gaining credence (according to Art Cashin) is a spike in the Yen before the crash caused a rapid unwinding of carry trade positions, an idea that may have first been noted by Trader's Narrative. The Yen has the most reliably low interest rate for the cary trade, and fear of a spike in the US rates could move money out of USD carry and back into Yen carry. As the bond market is an order of magnitude beyond the stock market in size, Forex dwarfs bonds. A little carry goes a long way to whipsaw stocks. 

We saw a bit of normalization of carry currencies Monday, but will this sustain? If the crash is the warning shot of a change across lots of bets that worked during the Hope Rally, a lot of positions need to be rotated, starting with the darling of the carry trade, the Australian Dollar (AUD). 

A quick comment about the AUD in a ZH post on the crash caught my eye about the AUD. The post noted how markets stopped at the same time worldwide across almost every type of market including futures, bonds, gold and forex. How could this be if it were merely a glitch in a few stocks? And how could this happen so swiftly unless a substantial majority of all trading is in the hands of a very small number of firms who made the decision to freeze over just a few minutes? The markets came back around the same time, but a few lagged, and this raises a red flag: 

Finally notice that the EURUSD and AUDUSD are slightly late to the game to recover. Although the auction resumes about the same time, they continue to print precipitously longer.  This is all the confirmation of Cluesix' AUD analysis I need.  No one is talking about it today, but after Asia tonight they will; Asia (and even China) are next.

I dug up the Cluesix Report: The Case Against the AUD. It observes that the AUD is the most overvalued currency in a developed market, too high by 30%. It is highly dependent on financials and commodities, and commodities may be in a huge bubble echo. The Lucky Country's real estate may be as much as 50% overvalued. Speculators and carry-traders are betting heavily on the AUD uptrend. 

The carry-trade may be rapidly unwinding in the wake of the crash. The AUD will suffer the most. 

Committing economic suicide won't help: a few days before the crash, the the Rudd government announced a 40% tax on profits from its mineral resources, to get a "fairer share" of the natural wealth of the country. Reaction was negative to shock at the utter foolhardiness of the blunder from down under. 

The Case Against the AUD

An Australian business man shared his thoughts on the Cluesix report with me (excerpted below the fold):

Time to Short the AUD?

The Canadian Loonie and the Australian Dollar have done really well relative to other currencies, bolstered by both relatively sound banking practices and resource exports to China. SlopeofHope, however, runs today a nice piece of technical analysis that suggests the AUD is about to turn. Near the bottom of the post is this chart and analysis (in blue below, excerpted):

"[I]t broke out of a rising wedge a few months ago, with a target of 62.5. Since that breakout, it has formed a right-angled and descending broadening formation, and it is currently very close to the top of that pattern at about 93. If it continues within the pattern, then the next target would be the lower trendline of the pattern, currently at 82.5, but very probably at 82 or 81.5 by the time it was reached. That would be a drop of more than 1000 pips."

The commentator does not believe it wil break up, in part because it has failed to make a new high since the rising wedge was breached, and looks like it is forming a triple top. 

Natural Gas is the Transitional Fuel to the Green Future

James Woolsey, former director of the CIA, comments in the WSJ today on how to break our dependence on foreign oil. It is a sensible approach, which begins with three uncomfortable factoids: 

• If oil gushes to $125/barrel, OPEC will control half the world's wealth
• If we impose a carbon tax of (say) $20/tonne, it will only raise gas prices by 20c
• if we "drill baby drill", it helps save $1B/day of imports, but cannot close the gap

Something else is required, and besides improvements to internal combustion engines, requiring new cars to be flex-fuel, and promoting adoption of electric cars, he most importantly recommends rotating the fleet of heavy tricks and buses to natural gas. Renewables are not yet proven as an economical and scalable solution to energy independence. Nat gas is the transitional fuel. 

Fracking has led to some huge natural gas finds in the US. (Fracking is the name for deep fracturing of shale, unleashing oil and gas trapped below.) We now have found large enough fields to potentially power the US for the next century. Besides the obvious places in TX, AK and LA, the Bakken formation in the Dakotas has huge potential, and the Marcellus formation under WV and PA is a super-giant which appears to have the second largest reserves globally. You can read more in this downloadable PDF, which comes courtesy of a reader, nspolar, who has been commenting on nat gas policy and made me aware of the Marcellus find. 

Ironically, the recent discoveries have trashed the price of gas to make it 21 times cheaper than oil (comparing a barrel at $85 to a mcf of gas at $4) - and some gas producers are going to the "dark side" and now exploring for oil. Still the Casey Report notes that when seven US nukes were shut down (temporarily) last week, nat gas spiked up 20%, so there is potential upside in gas as the summer energy season comes.

(note: an MCF of gas has 1.03 MMBTU of energy, so $/mcf is very close to $/btu)

It is a curious story how we missed the Marcellus field in the places where oil was first discovered. It is also not clear how much of the potential is actually recoverable. The discovery came from fracking, a process which is stirring political resistance in Washington. 

Nat gas has a number of wonderful properties, including easy distribution and relatively clean burning (especially when compared with coal or oil). It solves a huge problem in rotating the fleet from gasoline to electric vehicles:

• it can power large trucks in a much cleaner fashion than diesel (trucks have the wrong weight ratio to be electrified)
• It can (potentially) power electric cars by being converted to hydrogen and filling a fuel cell, extending the range and removing the need for a gasoline engine range extender

The EPA Co2 regs may be the next shoe to drop, substituting for fiat what could not be achieved via open politics. The EPA imposed new rules on cars, but their upcoming rules on power plants remain murky. It would be a supreme irony if we finally found the transitional fuel to move off imported oil just as political winds shifted against it, deepening our dependence as we chase unproven renewable methods of energy production. 

Wind Power Growth is Slowing

Interesting report today from the American Wind Energy Association: US wind power installed over 10 GW last year, but installations have been slowing since 2008. This may be a consequence of the Great Recession and not a trend, but it is worth watching if Wind picks up in '10. Wind is a cash crop in Iowa, which gets the highest percent of power from wind (14%); and is a big business in Texas, which has the largest wind farms (of course! everything's bigger in Texas). Here are suggestions on how to invest in wind, from Sustainable Business:

• GE Energy (GE) remained #1 in US wind turbine sales
• NextEra Energy Resources (FPL) continued to lead in wind farm ownership
• Xcel Energy (XEL) continued to lead utilities in wind power usage.

Lazy Trader Market Playbook

I had thought the easiest trading strategy was the seasonal market timing approach of Sy Harding: buy in Nov when the MACD crosses, and sell in May when it uncrosses. Two decisions a year that deliver very high returns over the past 30 years. Now here comes another, which would be pretty funny if it didn't seem to work so well in the final throes of this Hope Rally. It may keep on working until it gets so well known it doesn't anymore, so be forewarned .. or maybe it works because it is so well known, and the powers that be are not arbitraging it away. From The Pragmatic Capitalist: 

The playbook for this market is simple:

1) Buy any dip greater than 0.25%

2) Go all-in on Friday afternoons in anticipation of the Monday rally

Greece Going Lehman On Us UPDATED

Big news this morning is Commerzbank pulling its repos that are supporting the Greek banks. These are overnight facilities, and may lead to runs on Greek banks. Unless someone steps in (IMF? IMF?) this should put the Greek banks into a liquidity meltdown. This chart from ZH shows the yield curve "pancaking" - going to flat - because the short term (3-6 month) rates have shot up, with spreads at an "all time record for a developed country."  This usually indicates a default coming. ZH predicts:

• failed next bond auction for Greece
• Euro drops below $1.30
• Greece pushed out of EU
• Euro to $1.15

Update mid-day: ZH reports that Greek banks have now called the remaining E17B of a 2008 backstop plan. Deposits have dropped E8.4B since Dec. The Bundesbank may be also close to pulling its life-support backing. They need to fund E8.2B rolling over in Apr20, and E27B over the next seven weeks.Tomorrow the head of the ECB is expected to provide its plan for Greece Last chance before they swallow the bitter pill the IMF is offering? 

(photo courtesy Telegraph.) 

Those contrarians among you may consider that if Greece accepts IMF's tough terms, default will be avoided and these bonds will pay handsomely (since their rates will drop all the way back on a bailout). 

The Logic For Bonds: California Munis

California is issuing more munis to bridge the state through a huge $20B deficit (on a $87B budget, which used to be an astounding $110B). The credit default swap rate of California has grown towards Greek levels - yet the offering sold out 25% more than expected. Floating $2B, Cal sold $2.5B at 5.65% for 30 year bonds. That interest rate is 1.2% higher than comparable munis elsewhere, a bigger spread than last time Cal did this (in Nov) where the spread was 'only' 90 bp. As the deficit in Cal has widened, the spreads have increased, but does this really indicate a risk of default?

My view is no. The last thing Cal will do is stop paying on these bonds. It needs them to manage through the ups and downs of tax revenues. 

An analogy for muni bonds is to the dot-com era, where the dot-coms threw everything overboard to stay afloat - except their web hosting. Their web sites were their lifeblood. The leading hosting service, Exodus, was a huge short waiting to happen, since its stock held up past the bubble bursting, until finally the dot-coms had to shut their sites down. 

You can see the behavior of the issuer in this over-subcribed issuance: rather than worry over the high interest rate (120 bp higher than other States), California issues even more, fearful of buyers at all. Hence the rates rise due to market noise, not the underlying risk. (Also note that the higher muni rates of Cal are still not anything like a junk bond rate - as long as Treasuries are still below historical norms, the bond market will keep munis relatively lowish).  Don't believe an efficient market hypothesis for California Munis right now - rates are driven by fear and greed. Fear by the issuer, greed by the happy buyers of relatively high tax-free rates. 

Historical Default Rates

Muni's historically have had low default rates, even when the issuer itself went bankrupt. In the Great Depression about 2000 cities defaulted, which led to Chapter 9 of the bankruptcy code, allowing them to go into restructuring - and save their bonds. Since this was passed in 1934, around 600 cities have had to file for Ch 9 - out of well over 40,000 municipal entities. A very low rate. 

The big one to fall in 1994 was Orange County, California, which initially defaulted on part of its debt, but eventually the bondholders were made whole. Orange County led to a series of reviews of muni default risk. The studies concluded that general obligation bonds have a very low default rate of about 1/4 of 1%, especially if Orange County is taken out as an an outlier due to unusual circumstances. Much riskier are special districts and industrial-development finance that issue under the name of a municipality. 

The lessons learned for munis are twofold:

• diversify, so one Orange Count does not hammer the whole portfolio (obvious)
• look inside the issuance to the real party at risk, and avoid special project finance

On the last item, there were higher electric-power project defaults in 1982 coming from a court ruling, but very low since, especially after changes in the 1986 Tax Reform Act. This suggests two risks in buying industrial development bonds: the underlying project may fail, and laws may change. Consequently, be wary of muni bonds fronting:

• industrial development
• green projects/renewable energy
• hospitals and education projects

Despite the desire to see reneweable energy get built, if the project relies on subsidies and coercion to survive, rather than underlying economics, laws can change and subsidies can evaporate, especially in a streesed financial climate - as in California! A similar risk may be there for hospital and school projects, given the likely changes in healthcare and education.

The Union Stranglehold

Make no mistake of fear despite the low historical default rate, even back in the Great Depression. Bloomberg issues a "bankruptcy bloodbath" story about Vallejo, Calif, the most recent major city to go into Ch 9. Vallejo is in trouble due to excessive demands of city unions, and the worry is that bondholders may have a partial default as part of a packaged deal. 

The new factor in munis is how laws have changed to advantage state unions. Still, Ch 9 would allow excessive union contracts and benefits to be voided. About half the States, however, prohibit by law their municipalities from using Ch 9, presumably to further entrench union contracts. Fortunately for California, it is not one of those States. (The list is in the Bloomberg story.) 

 

A recent article, Plundering California: How Public-Sector Unions Brought The State To Its Knees, has now become the book Plunder!, discussing how public sector unions like Visigoths have sacked States across the nation. The author posted the Readers Digest version in the WSJ. Memorable anecdotes include:

• the average pay in Orange County for a fireman is $175k, and allows retirement at 90% of the final year's pay for life, including the life of his/her spouse
• 82% of chief-level Highway Patrol employees discover a disabling injury about a year before they retire, which gives them extra benefits; very few seem job-related
• teachers and police get shielded from dismissal, to the point that school districts don't even try to remove misbehaving teachers

It used to be public workers took lower pay but had better retirement. Now they get higher pay and much better retirement. Such a deal! 

It used to be most of the spending on K12 education went to teachers, principals, buses and schools. Cal actually ranks low on support people at the school level, but I recall that in the '90s California spent only 60% of its education budget on actual education (teachers, principals, buses, schools) and the rest on an over-paid bureaucracy in Sacramento, the State capital. A decade later and that 60% is down to 50%, with half of the education budget now flowing into those nefarious bureaucrats. These percents are probably overblown for effect, but the impact is clear: unions and administration are bleeding the State budget dry while letting the vaunted California K12 system fall to the bottom of the heap. Something has to change. 

What Happened to the Golden State?

Californians sigh thinking of how golden the State was in the '60s. On lower taxes and spending per capita, it had the best public schools in the country, new freeways that flowed, cheap housing, almost-free universities, cheap energy, heavy industry, and seemingly unlimited growth. Today on higher taxes, something like 2x the real spending per capita on education, and very high energy costs, it has the second worst K12 public schools in the country (thanks, Mississippi!), crumbling roads, riots over tuition in colleges, and a list of woes that overwhelms. 

I went to a rally for Meg Whitman for Governor, and the first question she was asked was, why would you want such a hopeless job? 

Most Californians can point to the key forks on the road to perdition:

1. 1977: Jerry Brown as governor allows State employees to unionize
2. 1978: Prop 13 freezes local taxes & pushes education funding to the State level
3. 1988: Prop 98 fixed the percent of spending on education at 40% (it is now above that)
4. 1999: Calpers (public employee retirement) sharply increases pensions

Jerry Brown is running against Meg Whitman. He admits that his biggest mistake was the 1977 law which allowed State workers to unionize. This, not Prop 13, has busted the budget and put California into chronic financial crises. Prop 13 combined with Prop 98 created a great flow of power to the State level, and with that power the giant sucking of funds out of education and into administration.

The pattern in California is for the surpluses in good years to be doled out to political favorites. In 1999 the huge dot-com surpluses went to public-sector union benefits. In 1996 surpluses went to K12 by reducing class size. And so forth time and again. During the bad times, these constituencies buckle down in a fight to hold their benefits, and the State in desperation issues more bonds to bridge the difference. The legislature remains eternally in deadlock. It is a terrible political situation when state unions can use campaign finance and other muscle to shake-down the taxpayer for benefits. This is a whole different dynamic than normal bribery of the legislature, since the state pays for the union benefits, state laws make it hard to remove the benefits, and the taxpayer is stiffed without apparent recourse. 

Clearly reform is necessary, but it is not clear the crisis is yet bad enough to cause the change that is required: to repeal Jerry Brown's 1977 law. 

The potential risk to munis is that attempts to fix the budget run into a rock and a hard place: education has to remain at that 40% level (which has crept higher than that under the Prop 98 rules) while unions fight to maintain their inflated benefits. Are bond payments now a weaker political constituency than schools (by law) or unions (by force)? This will be tested in the Ch 9 settlement in Vallejo. 

The Need for Tax Reform

The underlying cause of the boom/bust cycle is the highly progressive tax system in California. It in a sense is more profit based than income based. During good times, it provides too much revenue to the State, which spends it and ratchets up the budget. During bad times it provides too little, and as unions fight to maintain their ill-gotten benefits, the muni bond market fills the gap, putting the muni market through its periodic conniptions of fear and greed. 

This is good for munis, since it drives rates up without materially affecting the risk of default. It is NOT good for the State. 

There is a tax reform proposal floating through the halls of Sacramento which makes sense: flatten the tax rates by broadening the tax base, and change to a more stable system that collects about the same in good and bad times. Simplified, it changes the sales tax to a business gross receipts tax, and the income tax to a flat rate. The plundering would continue, but with less of a pool of excessive tax revenues to feed off of in good times. 

My take is that the tax reform is more likely than the repeal of the 1977 union law. It would improve the climate for muni bonds, since it would make tax revenues more reliable. Also, after Orange County default, the muni market recovered quickly. Any mistake in Vallejo that partially effects bonds is likely to be met by even stronger support for avoiding bond default elsewhere. And momentarily higher rates, a great buying opportunity.

There still is gold in the Golden State, in muni bonds. 

----

note: this is the second in a multi-part series on bonds

Investing in Media, Or How I Learned to Stop Worrying and Love the Internet

And the Academy Award for Best Picture goes to ... 

If justice were served, James Cameron would get Best Director for Avatar, since he has pushed the state of the art in CGI to make 3G a breakthrough, and The Hurt Locker would get Best Picture, for being a small indie film with a big character study. The insider read is the opposite, a rare spit where Avatar gets Best Picture and Cameron's ex gets Best Director.  You'll likely know by the time you read this. Whichever wins, or a dark horse, Avatar is a huge step forward towards a new trend in film making, Cinemé Sensation, where CGI and 3D create an experience which can only be truly enjoyed in large theaters. Even a relative dud like Wonderland draws in huge crowds. 

We are seeing a rapid transformation of video under the impact of technology across time, space and depth:

1. Depth: Cinemé Sensation, film as sensation not story
2. Time: On demand, a coming revolution in television away from broadcast
3. Space: The Internet allows viewing from new devices almost anywhere

The real 3D revolution is how technology will soon allow anything to be seen anywhere at anytime. The interesting question is where to invest. 

Cinemé Sensation

I rushed out to see Wonderland, and although the story is slow, the acting disconnected and the action listless, the experience achieves a new sense of depth where it is difficult to tell what is real and what is artificial. I knew this was a step forward when Alice stepped into Underland (the real name) and dust came up around her feet. 

Avatar and Wonderland represent depth coming to video. Our kids have been seeing this coming, with the latest console games approaching a striking realism. With the budgets for big pictures, the CGI of Pixar and the new 3G technology developed by James Cameron, we are rapidly approaching the moment when virtually any imaginable story and landscape can be realized with stunning realism and depth.

As with any new technology hitting Hollywood, the rush to amaze can get way ahead of the tenets of film-making. At least in Wonderland they improved the story, creating a plot and motion forward that was lacking from the source material. (Go read the original Alice - she just wanders around.) The woodiness probably comes from the incessant green screens needed as backdrops for CGI to later fill. How to have a relationship on screen with an imaginary cheshire cat? At times the whole film seemed to disappear into effect, until only the grin of the animator remained. 

They key to the Cinema of Sensation is to make a great film, not just a great sensation.

Film is about story. Much has been made of how derivative the story was in Avatar, a remake of Ferngulley down to the glowing forest, the magic tree and the evil white people:

>

Yet it had a story and a compelling set of characters. Compare that to George Lucas's three prequels to Star Wars, where George forgot all those tenets of film-making that he learned in Film School. 

CGI killed the movie star:

This is part 1 of 7. The rest are here. 

Investing in Cinemé Sensation is fraught with all the risks of investing in media properties. It is a hits business, and even the insiders get it wrong more than right. Right now every 3D flick will get an enthusiast audience, waiting for the next Avatar, but they will have to slog through a lot of Phantom Menaces to get there. Instead of creating compelling new stories, Hollywood is throwing old remakes at the unsuspecting audience. Even Spiderman, only eight years in the can, is being remade in 3D. As an investor, stay away. The audience can get tired of this very quickly, and go back to the Hurt Lockers. 

Yet if the industry is up to the challenge, the content can improve to levels not yet imagined, where CGI can create landscapes and scenes not economic or even possible with traditional technology. In the development of the Cinema of Sensation, the first breakthrough might have been Titanic, but the innovation that amazed for what the art could become was The Matrix. Unfortunately the sequels squandered an impressive start.

The last time we had such a flowering of innovation and pushing the envelope of a medium was right on the cusp of the breakup of the studio system and the rise of television. Back then theater audiences had a wide acceptance and indeed anticipation of seeing a cartoon with a film. We ultimately saw innovation in content that led to masterpieces like this, which I see as the ultimate cartoon:

What about catching the 3D sensations on TV? CES 2010 was all about 3DTV, but I think it premature. They very elements that make Wonderland work on the big screen will make it a bust on the boob tube. The weaknesses in story and character will loom large, and the 3D wonders will seem small. Television is a social medium, and hiding behind goofy glasses will rapidly diminish the enjoyment. You can read more of my impressions from CES in this companion piece on 3 Things to know about 3D. 

On-Demand

The Internet is causing a change in television that will overturn the current order. 

The revolution will be televised. It will not just be on TV, it will be TV: 

The broadcast medium is the massage, the way the business is done. Commercials come in pods, shows follow shows, programming is all about how to place the lineup within set time and counter-programming constraints. A whole industry of Mad Men has arisen over how to handle two issues: how to turn a show into a hit, and how to target ads to audience. 

Tivo started the change, with time-shifting of shows. A baby step until Cablevision won its case to put a network DVR layer between the shows and the viewers. Other than live events, viewers prefer to control the time of watching. The power of the Season Pass to seamlessly record all versions of a show needs to be experienced. 

The change is accelerating with over-the-top TV, the moniker for Internet-connected TVs and blu-ray players. Now the TV can bypass broadcast and access the vast library of content (legal and illegal) going online. 

This can play havoc with the windows and various roll-out schedules of studios to release content. Recently Warner negotiated with Netflix and Redbox (the $1 a day DVD kiosk) to give a 28 day window between DVD release and rental. Disney in particular has been very careful with its evergreen titles, those movies that appeal to kids and can roll out Mickey fresh every 7 years to a new generation of lovable rug rats. Yet expect these attempts by the studios to manage their library to come against resistance. The Internet will try to find a way around any blockage. Consider this cartoon from SNL:

Yet the revolution is not to be denied. The major change on-demand will have on TV is to change how programming and advertising are done. How to promote a new show when you can't simply have the audience stay on the same channel when one show ends and the new one starts? How to get them to watch ads when they can flip away once the title ends? These questions have not been answered.

For investors the revolution will create opportunities to invest in the marketing-media complex, that vast enterprise between broadcast TV and ad agencies that is well over a $60B business today. For disclosure, I have investments in Aggregate Knowledge, which supplies a realtime ad engine to ad agencies; in Verismo, which has an over-the-top TV box, and Widevine, the leading DRM supplier to CE devices to enable OTT TV. This is an area to watch.

The Internet Everywhere

The Internet is not a new medium. This has confused investors over the past decade. Gobs of time and money have gone into new studios and web video outlets like Veoh, which had the help of Michael Eisner, and recently went under, or BitTorrent, with has flopped back and forth trying to turn itself into a new video service. Occasionally a breakout happens, like the Fred Channel over on YouTube or LonelyGirl15. What makes these work is they follow the tenets of storytelling in short form. Does this make for a new medium, a place for new forms of content to emerge, the home of short-form video?

Radio is a medium, where the distribution and device are entwined. Television is a medium, ditto. We have all heard how Film started as theater with a camera, and TV as radio with pictures, until the unique characteristics of the medium were learned and exploited. 

The Internet in a sense is an anti-medium, where the distribution and device are now divorced. The Internet can distribute anything, and does: education, information, short-form vids, TV, stolen movies, and porn of such depravity and awfulness it boggles. 

Cable started as mere distribution. For those on their high horses about piracy in the Internet, just reflect on how cable started: taking over-the-air broadcast for free and re-distributing it to the edges of broadcast coverage. Cable took off when networks began to realize they could create new programming to compete with the broadcasters. HBO, MTV and ESPN led the revolution back then. 

In this same sense as the Internet, cable did not create a new medium, but vastly expanded the distribution of video to an old medium, TV. This expansion led to innovation, such as MTV and the Music Video. Again, get off your hihh-horse and think of how something given for free let MTV create a franchise for pay. Even early on the creativity of music videos sparkled:

SImilarly the Internet is going to expand video, especially to new venues. How to create growth in entertainment? Movies are trying via high-priced tickets for 3D, but it does not appear to effect overall viewing time in theaters. Television has ever more channels and a growing library of on-demand movies, yet this has barely budged the needle on TV viewing. Instead, viewing is going to other times and places: PCs, mobile devices, out-of-home venues. 

Rather than thinking of the Internet as a new medium, think of the PC as one. It enables short-from videos, has spawned YouTube, and seems to love music videos. It thrives on social media. It is solving the problem of promoting new shows on on-demand TV: use social networks!  It is smashing the economics of advertising, and may turn the TV industry from ad-supported to paid-for.

Now fast forward to mobile TV, and tablet TV. A new slate of social media, a new set of venues, and expand TV viewing across time and space.

I will continue to expand on these points by elevating this post to a persistent page. Let me just leave you with this: the vast expansion of video into the library can enable new delights. It can also enable this, which I saw in a post entitled This is What You See Right Before You Die. With all respect to the artist, it looks like a cyborg has taken over a singer on Russian TV, as if the machine is now inside its human avatar, trying to be Frank Sinatra. Is this the future bequeathed by James Cameron?

The Logic For Bonds: Fundamentals

When the Fed truly begins to back off its low rates and quantitative easing (QE), we should expect bond rates to rise and bonds to fall. The right strategy is to buy the short end, let the rise happen, then swap to the long end. This seems to encapsulate the Chinese strategy, which has been to sell the long bond and buy in the shorter end (two year primarily). Even if rates jump, and the short stuff drops, they can be held to maturity to maintain value - but moving short too early risks dreadfully low rates and dismal returns while the longer instruments reward their holders. 

It is tricky to throw the magic sticks and divine the Fed, since the Fed purposely obfuscates its intentions. Case in point: after the recent raise in the discount rate it has gone out of its way to say real tightening is a ways off. 

It is also tricky to listen to the pundits. Right now they go both ways:

• The Black Swan guy, Taleb, says "every single human being" should short Treasuries
• Everyone's favorite analyst, David Rosenberg, says to go long Treasuries

Too bad they are on both sides: 

the greatest returns are when a widely-held belief of investors proves incorrect

Instead we have a balance of views. You can see this in the behavior of bonds recently. The long bond was climbing (rates fell) through most of the Hope Rally, but beginning in October began to fall (rates rose). So far in 2010 it has been sideways. We sit on a cusp: will rates continue to rise to above 5%?  Or are they about to drop? 

This is a complex subject, and I will walk through it in a series of posts, beginning with the conventional wisdom of fundamentals. 

Is it Time to Exit Munis? UPDATED

I went into munis big time a year ago when rates spiked. Now it may be the time to rotate out. Comments for readers would be welcome! Here is the logic:

Muni yields drop to ten-week low, and yet the yield curve today is at record steepness. The long bond seems destined for over 5%, and we now see projections of 6% (from Citi). The Fed is unwinding QE in Treasuries, which makes higher rates likely in 2010; will this also drive muni rates back up? Past history says the yield curve gets even steeper until about 18 months after a recession ends. Assuming we ended in Q3, this targets higher rates into 2011.

Sure, there are some distressed bond States, such as NY and California, but this question is not about the potential failure of muni's to pay. At the top in 2000, dot-coms cut everything back except their lifeblood, their web sites. (Exodus was a short waiting to happen, since it was the beneficiary of those walking-dead websites, until they finally had to turn off the lights, and then Exodus crashed too.) In the coming '10s, States will do everything to cut back except their lifeblood, the muni bond market.

Right now money flowing into munis is slowing. This might just be year-end tax planning, with a new surge in January. Or it may signal a change of trend.

UPDATE 12/23: after further analysis I came up with this:

• Muni trading desk are lightly staffed right now, so volume is low. Softness in munis may reflect seasonal slowness, not a trend
• Munis still are at relatively high yields compared with Treasuries of similar duration, meaning the rise in Treasuries is more bringing them back in alignment, and may not move munis much
• The Stimulus included a Build America Bond - a muni that is not tax-free at the Federal level, but comes with a 35% interest rebate to compensate. This is a sneaky way to remove the tax break for munis. Although BABs are relatively small right now, the more they grow the more attractive the traditional triple-tax-free bonds will be

Implication: hold those high-rate triple-tax-free munis. 

Investing in CleanTech, Post Copenhagen UPDATED

Ever since the ClimateGate scandal broke, I have been asked "how do we play this?" With the chaotic failure of Copenhagen, this is a more pressing question, as bets are being shuffled in cleantech with the new change of assumptions. At a high level the primary investment implications are to move out of sectors that require government subsidies or carbon taxes, and into sectors with economic competitiveness. This is not to say we won't see attempts to pass cap™ or carbon taxes, but they seem likely to give way to a different spin on cleantech, that of saving green jobs not saving the planet.

UPDATE 12/22: Also, the exuberance for CleanTech investing has abated (see chart, and note how it says cleantech investing has "surged" even as the chart shows a 50% drop this year). The WSJ ran a post-Copenhagen piece today about cleantech firms having to "reset" their strategies. They also agree with my thesis posted Dec7 of a change in the rationale to "economic development or reducing dependence on Mideast oil, [rather] than at threats posed by global warming." 

 

With this in mind, we need to start where green technologies are or will soon be price competitive. Casey Research has a really useful newsletter on point, and here is on of their charts:

 

Let's walk through major CleanTech sectors with this chart in mind.

Carbon Trading

This one is easy: stay away, stay far away. This will be a huge casualty of the failure at Copenhagen. Even as the masses assembled, Denmark was marked with a huge scandal over fraud in carbon markets. Australia's Cap & Trade bill failed on the eve of the confab. The Danish scams were in the Billions of Kroner. Now the scams are being found more broadly, across Europe. Organized crime may have skimmed an astounding 5B Euros ($7.4B).

UPDATE 12/22: This chart from the WSJ shows how carbon allowances have plunged post Copenhagen. To make carbon-free technologies like solar competitive, these allowances need to be above E60/tonne. It has fallen in half from a recent high of E25 to below E12.50.  Quite a drag, says the Silicon Valley cleantech press. 

Geothermal

The authors of the Casey Energy Report make a great case for geothermal. Right now geothermal is used near hotspots of surface geothermal activity. The core insight is that future technology can turn almost any area into a geothermal hotspot, providing a 24/7 energy source which has very low incremental costs once set up. No need to worry over the sun shining or the wind blowing. There is a public play here, recommended by David Fessler: 

This is an area with plenty of potential, particularly in the western United States. When it comes to profitable, large-scale geothermal and recovered power producers, Ormat Technologies (NYSE: ORA) is pretty much the “Lone Ranger,” but many smaller operations will likely fire up geothermal plants in 2010.

UPDATE 12/22: the biggest setback to geothermal was a Swiss project which triggered an earthquake. There is the well-funded (pun intended) AltaRock project just north of SF, near the San Andreas fault. Local geologists seem a bit sanguine about this. Hmmm. Deep drilling and pushing pressurized water down causes small earthquakes. Why no earthquakes in oil country, where they drill deeper and also push pressurized water and Co2 down? The very structures which trap pools of oil also bury geothermal effects, and make make geothermal diseconomical; it works best where the geothermal activity is near the surface. 

Wind

T. Boone Pickens made a play for wind in Texas, then very visibly backed out of it. Wind would work well offshore of New England, but has been blocked by the Kennedys, among others, for ruining their views. In general, a spine of wind down the Great Plains would make sense, given the wind there. Windmills could become a cash crop. 

Part of what deterred T. Boone as well, besides not being able to shake down governments for subsidies nor investors for funding, was the need to connect the windmills to the grid. In vast areas where wind would work, the grid is inadequate, non-existent, or caught in political wrangling. Hard to make wind a cash crop if the grid won't connect to it! Watch for approvals of new powerlines to renewable areas to inform as to where to focus investments, such as just happened in SoCal. 

A microcosm of the wind market is the Bonneville Power Authority, which runs hydro on the mighty Columbia River and wind in the breezy Columbia Gorge. The actual output in practice is far less than expected. This calls into question the cost estimates of wind. The BPA has found that at peak wind, they would overwhelm the transmission lines, and have to cut off turbines; and further have had to dump water over the dam without getting power from it due to the way nature works (the water flows even as the wind blows).

If you want to play this, David Fessler has a wind recommendation: 

Wind installations will continue during 2010, but well off the record pace of 2008. Nearly 300,000 megawatts of wind farms are waiting for grid enhancements and upgrades. Vestas (Nasdaq: VWDRY.PK) is the world’s largest wind turbine manufacturer, with over 39,000 turbines installed around the world.

Solar

The solar sector is 3x more expensive other mainline energy sources, making it a bad bet for base energy production. Potentially solar can run down a cost curve, but it is having a terrible time getting out of the starting gate. I have an indirect interest in BrightSource, a solar-thermal engineering firm. Solar-thermal uses mirrors in the desert to drive a heat pump to spin a turbine. The team behind BrightSource was the pioneering team in the '80s behind solar-thermal in that wave of energy consciousness, and near the end had 90% market share. Yet steadily the subsidies were pulled as oil continued to get cheaper and cheaper, and the lights were turned out on their firm. Their new company hit a serious bump in the road this summer, when their plans to build a huge planet in the Mojave Desert were stymied by the local eco crowd (NIMBY!) as well as some obscure political interest by Senator Diane Feinstein.

UPDATE 12/22: that obscure interest of DiFi got revealed big-time today. The WSJ reported that she is now pushing for a huge National Monument to cover much of the Mojave. (See map.) She must have thought the timing right, given the positive reception to the recent PBS series The National Parks: America's Best Idea, by Ken Burns. She would protect over a million acres. California has required utilities to invest in solar, and they would need 128,000 acres for that; but almost a million acres of projects have been proposed (which is down from a initial 2.5 million acres). Projects are being cancelled; the NYT says DiFi's move has further scuttled 13 big solar plants and wind farms planned for the region. The bill does try to speed up approval, but the local NIMBY crowd will still have to be dealt with. The WSJ notes that:

The Mojave is particularly attractive because it not only offers nearly uninterrupted days of bright sunshine in a sparsely populated area, but lies near a major electric-transmission corridor from California to Nevada.

 

I suppose there is always Arizona next door, but this puts a huge damper on utility-scale Solar. 

Possibly the solution lies in photovoltaic cells (PVs). The SciAm article A Solar Grand Plan (you can download it here) paints a compelling picture of mass PV farms across the Desert Southwest, joining that theoretical spine of wind down the Plains. It is difficult to see how it is more than science fiction, unfortunately. It requires some engineering breakthroughs, such as mass storage of energy in caves/mines using compressed air, and superconducting DC lines that stretch from the Desert Southwest to populated centers across the country. More daunting is the need for 30,000 sq miles (20 million acres) to be covered with PV cells along with concrete, power lines, roads, and the support for a massive construction project. To give that perspective, that is the size of land between SF and LA, from the ocean to the mountains. Hard to see how that swathe can be available somewhere, and more than that can be built upon. That is a lot of Mojave Deserts, and we just lost that one. We might be able to find some of that area available in Arizona, but the system needs water to construct and water to maintain (PVs get dusty).

Still, it appears that distributed PV cells (small panels on homes and businesses) have a market, because the savings at the retail end of the utility price curve are enough at the margin to cover the 3x higher cost. Currently the Chinese are dumping PVs into the US, reusing excess semiconductor capacity. This is depressing domestic production but incenting domestic uses. A number of thin-film PVs are coming online in 2010. (Disclosure: I have an indirect interest in Miasole, one of the thin- film ventures). Perhaps the Chinese PVs will make a market for thin-film.

Caution is warranted in solar, as the initial exuberance has fallen to hard economic and logistical realities. Nonetheless I agree with David Fessler's comments on this sector:

This is one sector that should continue to see consolidation in 2010. With an excess of silicon wafer capacity and new low-cost thin-film designs just now coming into production, expect the transition from silicon-based panels to thin film to continue in 2010. And despite the negative press, one of the ultimate winners in this space will be First Solar (Nasdaq: FSLR).

Here is a bit more on First Solar, from Toby Shute, who posts on solar regularly in SeekingAlph:

The thin-film kingpin came back the next day with guidance for 2010, plus news of a major capacity expansion. The forecast was notable in that it went beyond the usual sales and margin figures, and it included free cash flow guidance. Free cash flow is a rare commodity in this capital-consuming industry. With such a robust financial profile, it's no surprise that First Solar is comfortable expanding its current capacity by nearly 50%

UPDATE 12/22: the story above about the loss of most of the Mojave for utility-scale solar puts a huge risk into First Solar. GreenBeat has this story:

It turns out First Solar has dropped four large-scale solar plant projects in California alone, according to a report from investment firm Wedbush Securities. In each of these cases, the company’s plans were denied by the Bureau of Land Management. At the same time, it was revealed that one of its 150-megawatt projects slated for 2,100 acres in Colorado has now also been cancelled.

The central message behind First Solar’s recent success was that utility-scale solar plants would soon be a reality. [Now] it looks like First Solar is having more trouble than it bargained for, boding even more poorly for others striving toward the same goals. In short, utility-scale solar could still be a ways away.

UPDATE 12/23: Solyndra, a thin-film maker competing with First Solar, is poised to go IPO. An analysis of their filing, however, shows they are way behind First Solar in their PV cell costs: they sell for $3.42/watt but make for $6.29/watt. Ouch. Apparently their PVs are easier to install, and that saves their buyers as much as $2-4/watt, dropping the effective cost to $2.79-4.79. But this doesn't appear competitive:

Compare this to First Solar (FSLR). First Solar's average manufacturing cost per watt declined by $0.23 per watt, or 21.3%, from $1.08 in the three months ended September 27, 2008 to $0.85 in the three months ended September 26, 2009.

Or compare it to a silicon solar vendor like Trony Solar (TRO). Trony Solar's average manufacturing cost was $1.15 per watt for the fiscal year ending June 30 this year, the company said in its SEC filing. From June to September, the company lowered the cost to $1.09 per watt.

Solyndra must also compete head-on with the plunging price of flat plate panels from BP Solar (BP), Suntech (STP), Mitsubishi, etc. while lowering their cost almost an order of magnitude from about $6 per Watt to under $1 per Watt.

Hence, First Solar still looks relatively attractive, but whether they are a buy on an absolute basis is unclear at best; first the collapse of utility-scale projects must be taken into account. Solyndra targets rooftops with a unique cylindrical design.

Natural Gas   

Nat gas seems to be the transitional fuel from oil to renewables like geothermal. We have had recent large discoveries, and gas has become cheaper than oil. In the longer run, nat gas may become the foundation of the so-called hydrogen economy, where it can be used to fill up hydrogen fuel cells (the CH4 in gas is converted to H). This is several years away from commercial development. 

There are many ways to play gas. Some ideas include ETFs like FCG or DIG.  (Please note that I am not endorsing these, just passing them on.)

There is a lot of backroom political wrangling over nat gas. if you go into this area, be sure to keep an eye on influence peddlers in Washington. Or hire your own!

Nuclear

Quick comment on nukes: there are a bunch of future models being designed. The most interesting uses Thorium as a fuel. A long-term play is to look into Thorium.

UPDATE 12/23: Thorium makes a better fuel than uranium: much safer. more abundant, less waste, and no proliferation potential. India and China in particular are all over it. The US considered and rejected Thorium reactors in the '60s precisely because it had so little waste; they wanted to use the uranium waste for bombs.  

UPDATE 12/22: Another play is to invest in compact nukes - small self-contained reactors that can power a large factory or a city. We have run nuclear powered subs and carriers for 50 years, safely; so why not use those design ideas commercially?

It turns out there are five fission and two fusion start-ups, including Hyperion, NuScale and Tri Alpha. Also, some of the large nuke builders like GE, Toshiba, Hitachi and Areva are looking at this. The reactors are small, some small enough to fit on a kitchen table. They are self-contained and can be thought of as nuclear batteries. They can be built in a factory, shipped to a site, and plunked in the ground. When they run low, they get pulled and replaced, and processed back at the factory. 

Sounds pretty compelling. What's the catch?  Bob Metcalfe, the inventor of Ethernet and a prominent venture capitalist, touted this idea in the WSJ, but said he wasn't investing himself. As he puts it: 

As venture capitalists, we at Polaris might have invested in one or two of these fission-energy start-ups. Alas, we had to pass. The problem with their business plans weren't their designs, but the high costs and astronomical risks of designing nuclear reactors for certification in Washington.

The start-ups estimate that it will cost each of them roughly $100 million and five years to get their small reactor designs certified by the Nuclear Regulatory Commission. About $50 million of each $100 million would go to the commission itself.

The problem with nukes is political, and reflects a common pattern when a new technology comes in: we first treat the new as different, and only later learn it really wasn't that different. Yet the damage is done and hard to unwind. 

My favorite example of this is the Fairness Doctrine in broadcasting. Under the First Amendment, no one would think of restricting the number of newspapers or limiting their editorial control. Yet when radio and later TV came in, this is precisely what happened. The rationale was that spectrum was limited, and so would be the voices; but ask yourself, are there more newspapers in your town, or radio & TV outlets? 

We lucked out in the US with the Internet, and I give Al Gore credit not for inventing it but for keeping the government's hooks away from it. 

We got very unlucky in the US over nukes. First, the Atomic Energy Commission was heavy-handed and excessively subsidized the industry, so a reaction was predictable. Second, a silly Hollywood movie, The China Syndrome, came out almost simultaneously with an incident at Three Mile Island. Fear trumpeted logic. No nukes in the US since then. Nukes are not really that much more difficult to manage than other toxic chemical plants, yet are seen as much riskier, and are buried in regulations, approval and litigation. 

The good news is even with the noose around their neck, nukes appear to be able to compete economically as base energy sources. SciAm has a good online site to learn more about nukes. 

While pushing for nukes may be good energy policy, it seems a tricky area for investors, too subject to the whims and fancies of craven politicians and emotive pressure from relatively uneducated voters. Maybe Metcalfe's "nuclear batteries" will be approved and then worth investing in. I would wait for that. 

If you feel compelled to find a play, those new nukes that are added to existing facilities, as extra reactors, are much more likely to be approved and operational in an investment time frame than new sitings. 

Electric Vehicles

A lot of action here, although little yet public. The nano-scale Lithium battery maker A123 went public this Fall, and is worth watching. Tesla Motors should go out in 2010 (disclosure: I have an indirect interest in Tesla). It should get a good reception, given it is the first one out. Fisker with its Karma plug-in should follow.

This may be a market where it is better to catch the early IPOs than wait. A lot of electrics will be coming out in the period from 2010-2012, including the Chevy Volt. The current hybrids are expected to give way to plug-in electrics of various designs. The primary battle is between all electrics like the Tesla and electrics with range-extenders (motors or fuel cells) like the Volt or the Karma. Toyota has a huge lead with the Prius, and recently announced a plug-in lithium-ion car with a motor range extender. Consequently the competition should get pretty fierce.

An interesting longer-term play is to invest in Lithium. All the future batteries are using lithium-ion technology. It is also stressed by laptop/netbook and mobile-phone demand. The coming tablet computers will further increase demand for lithium.

UPDATE 12/26: Besides investing directly in lithium, one could invest in lithium battery companies such as A123. A contrarian perspective on lithium calculates that the lithium future has been fully baked into the valuation of A123 and competitors, and that traditional lead-acid batteries are undervalued. Perhaps, but never under-estimate the value of a good old fashioned bubble, in this case an electric car bubble, which has not yet warmed up. Again, my suggestion is play the early IPOs in this space, if you can.

As a personal note, four of the five cars in my family (including kids who have flown the coop) are hybrids. I think they drive better - a smoother and quieter ride. While the GW alarmism will abate, and carbon-trading flop, the transition to electric vehicles will continue. 

Efficiency

Another whole category is energy management, ranging from the Smart Grid for utilities, to energy metering for businesses and homes, and down to systems to lower energy usage in devices. Again, few companies yet public, but a plethora being invested in via venture capital and the Dept of Energy. This is a space to watch. 

UPDATE 12/24: Other pundits are weighing in on the implications of Copenhagen for investors. Greentech Media agrees that the focus should shift away from grandiose climate legislation towards subsidies for 'green jobs' and especially to energy efficiency. The investment plays here may stretch outside of VC into PE and public companies:

Many VCs will look for IT-based ways to try to play the wave: Home energy monitoring, LED-based lighting, etc. are already popular sectors and will become more so. But I think VCs will be left out of most of the emerging wave of energy efficiency adoption, because it will be mostly service-based, and tapping into the biggest pools of incentives will require working with utilities and governments. Non-VC investors may be the most critical source of capital for energy efficiency. And I also expect a fair amount of mid-market private equity activity in the sector as well.

A word of caution on investing in areas with "green jobs". Much of the green jobs push will be for core manufacturing, often combined with temporary construction jobs (building solar plants, putting solar cells on buildings, etc.)  Examples that would drive green jobs are PV cells and batteries for electric cares. Yet, we already have a glut in PV cells and a possible glut in Lithium-Ion batteries that may disappoint investments in core manufacturing. The rush to produce capacity, which until last year was funded with cheap capital, has gotten way ahead of demand for the end-use products built on top, such as electric cars or utility-scale solar.

One final note of caution that applies even to energy efficiency deals: avoid investing in areas with heavy government subsidy, whether from the Stimulus bill or from Dept of Energy programs. In particular, Smart Grid ventures may be over-invested in. In areas without heavy government subsidy, energy efficiency deals will be more attractive since the ROI from saving cost is the gift that keeps on giving.

Mobile Internet May Be the Next Driver of Growth

Speculative tech stocks tend to do well coming out of a recession, so we may get a barn-burner coming out of this great Recession. I remember the PC Bubble in 1980-83, as we came out of (twice!) a severe double-dip recession. For those who follow Kondratieff Winter, when we come out some new factor of production will drive Kondratieff Spring in the next cycle. Many VCs are betting on cleantech, but the recent ClimateGate scandal puts a bit of a chill on that.

Morgan Stanley put out a report today touting the Mobile Internet. I have personally invested in this category, and been chairman of a mobile Internet venture, so I already believe this is one of the key drivers of the next venture wave up. The report (actually several reports, all downloadable from this link) makes a few key points, including:

• It is bigger than the desktop Internet
• New winners will emerge
• It is ramping faster than the desktop Internet
• Emerging markets will be huge, leafrogging poor landline infrastructure

Investment Implications of a Dollar Bottom

I was at an Xmas party last night and asked how can the Dollar rise when we have such excess liquidity from Helicopter Ben and such low rates under ZIRP (zero interest rate policy)? I explained that it would happen if the US Peso fell slower than other currencies. Of course there is more to it than that, including the potential short squeeze against the Dollar Carry Trade, but the essential point remains: when all countries are racing like hares to the bottom, the turtle currencies will rise.

Right now the Japanese are facing a double-dip economy, and hence a weaker Yen; and Euroland is facing a growing number of sovereign default risk (Greece etc.), hence a weaker Euro. While this is unlikely to pull down the global economy, it seems to be driving down the Euro, which is down big today. It is also emboldening the Bond Hawks, who are putting pressure on countries pursuing a weak currency.

For a week I have been on Sea Change Watch: has the Dollar bottomed? The key was whether the pattern of a Dollar Dump Sunday and a Stock Pump Monday would continue - it didn't. Yves then weighed in on the Dollar Carry Change ending.This chart and the commentary from Bespoke Investment Group show broader recognition of this change. Their investment recommendation:

• shift from multinationals with heavy overseas revenues (where a weak Dollar helps)
• to those with heavy domestic revenue (where a strong Dollar helps). 

In other markets, we see:

• the bursting of a gold bubble
• the fast drop in oil. Yves has a piece at ZH on oil.

In equities we are in the early stages of the Santa Rally. How can the Dollar drop and the Dow rise? The inverse correlation is well recognized but not precise. A lot of it comes from overseas investors hedging the Dollar drop in US equities. Now they have troubles in their homelands. Also, institutions are beginning to lighten up for the holidays, and the retail investor is driving equities. Why else the Santa Rally? These folks are impervious to larger Forex trends. Watch for equities to catch up to the Dollar Bottom after the new year.

In the near term, be prepared for a Dollar pullback and Euro bounce. We might get a mini-version of the Sunday Dump over the weekend, but this is more a technical bounce than a change back. If so, we should also get a Stock Pump next week, especially leading into the FOMC meeting mid-week.

Online Retail is Up - Is Amazon Now A Short?

Amazon has skyrocketed due to clear indications that online will be the big retail win this season. Fedex reported a huge upside surprise in earnings, driven mostly by international shipments - but also by small packages, meaning online retail. Yet this chart shows irrational exuberance in Amazon.  The author has been bashing Amazon for months, to his chagrin so far, but the chart shows how ridiculous the price has become.

This might be best played at the end of the Santa Rally, which typically peaks in early January after the holiday sales season, particularly after the bargain days post Xmas. (Recall I have been saying that retail will be late and discount-driven this year.) 

Compounding the pending risks to Amazon are a surprising and disappointing report today that consumer credit is down again. How can retail sustain when consumers lack buying power? There even was a recent story of a surprising amount of cash used at retail (I lost track of the link). Stretching in the rainy day fund to keep the kids happy? 

The other risk is a downside surprise in unemployment in January, which will be reported in early February. Seasonal adjustments made the 10.2% blip, and also made the 10% drop that has so spooked markets the last few days. These adjustments now flip the other way after the temp worker retail sales season ends. Underneath the unemployment rate is unemployment reality. This chart from the Big Picture shows that ALL of the increase have been in government-related sectors. the private sector is still in the dumpster.

 

Investment Implications of ClimateGate

A huge scandal is brewing in climate science. You can read about it in my companion post, Fear and Loathing in Global Warming. It suggest a small cabal at the center of climate science has engaged in a massive fraud on the rest of us. Since this cabal are the keepers of the data, it calls into question the climate record. Satellite data (which does run through their hands) has been diverging from their data, showing a ten year cooling trend that may be accelerating down. For purposes of this blog, how might this affect markets and investing?

I scanned the blogosphere this morning and saw little thinking on this so far. James Delingpole in British Telegraph thinks it will put the kabash on alternative energy investments: "If you own any shares in alternative energy companies I should start dumping them NOW."

This is plausible since the scandal will make it improbable that any grandiose climate treaty passes, and unlikely that the Cap & Trade bill gets through the Senate. John McCain (remember him?) had already reversed his support of a climate bill, and will most likely now put his energy into killing it. Without either subsidies or increased costs on traditional energy, it will be extremely hard for alt energy to get established. Our experience form the '80s is when the subsidies subside, the projects die. 

A lot of alt energy funding is in the pipeline, however, and it is unlikely it gets re-directed. This also happened in the '80s, where investment continued to get poured into alt energy like the SynFuels Corporation and Solar-Thermal plants in the desert; but by the early '90s those efforts had been fully funded by those prior commitments, and could not get continued investment. Kerplunk.

An early test of this thesis may happen early next year: Tesla motors is planning to file to go IPO. Tesla is a high profile maker of all-electric cars. (Note: I have an indirect interest in Tesla through a venture fund investment, and would welcome a successful IPO.) Tesla is following the successful IPO of A123, an electric car battery maker.

In general, however, if the subsidized investments like wind, biofuels and solar fade, what should attract more funding are the hard economic alternatives, essentially four:

1. Nukes (especially more reactors in existing plants - fewer permit issues)
2. Geothermal (cost competitive today and under-exploited)
3. Natural gas (think: fuel cells in vehicles)
4. Conservation and energy management

A broader implication of the scandal may be to undermine support for the progressive agenda being pushed by Obama. Obama has identified himself with climate change and therefore with association to the climate cabal. ClimateGate will remove the pretenses that anchor the progressive argument - that interference in almost all aspects of human activity is justified to prevent runaway global warming.(Don't think that is the agenda? Check this example out.)

In struggling to get the healthcare bill passed (key vote today), all his early pretense of 'bending the cost curve' has gone away. Maybe he gets a jobs bill passed, but after healthcare, it now appears his agenda will be largely stillborn. Like scales from our eyes, the progressive pretenses are falling away.

This change should be long-term bullish as it should reduce the interference in the private economy and reduce future increases in already-huge Federal deficits. In the short run it should throw uncertainty back into the market.

Before You Jump Back Into Real Estate, Read This

Time for a little public service for those crazies buying back into housing. Amherst Securities did a report on the huge shadow overhang in the housing market. They count 7M units already delinquent, up from 1.3M in 2005 and more than the 5.2M annual home sales right now. They estimate an additional 300K go delinquent each month, or another 1M since this chart ended in Q2. 

The government's vaunted modification program doesn't seem to have much impact, as 70% of them go delinquent again within a year. Maybe 1M of the overhang could be modified if all went well, but then 700K would go back into the overhang a year later. In other words, best case the modifications would only save a month's accumulation of more overhang. 

They look a little deeper into Riverside CA, which has 1,372 units for sale out of 34,800 total properties. If you add to the listings the foreclosures not yet listed, houses about to be auctioned off, and houses with a notice of default, you find over 7,000 units are in the shadow inventory - 20% of all houses in the city! Now, Riverside like Vegas and places in Florida was at the center of the irresponsible government-backed no-money-down loans of the housing bubble, so this sort of shadow inventory of 5x the listings is at the extreme. But they sample other places, and find LA is a 3x overhang, Vegas is 4x and NYC over 1x. San Diego, where some of the crazy buying is going on, is at 3.4x overhang - the buyers are nuts! 

The problem right now is that defaults are happening much faster than liquidations, so the overhang is growing. See chart, which divides by loan type. Subprime are past their peak defaults, and the liquidation has caught up. AltA and OptionARMs are close. The problem is now in the Prime loans.

They conclude with an analysis why prices and sales seems to have bottomed: seasonal factors have given a temporary plateau.  But the seasonal buoyant period is over, and both prices and sales should now resume a slump. 

If you jumped back in and are now stuck, you have another option: sue! Bloomberg reports how condo buyers in Florida are suing for deposit refunds. Condos they put a deposit on in 2006 at $1000 sq ft are now down as much as 8x, and the worry is they will soon drop 10x or below $100 sq ft, the level in 1989! At those levels, maybe the crazies will jump back in and bottom fish ... 

Investment Crossroads for Yasi

Yasi went long despite my Roadmap post.  Now she faces a decision.  Neely is confident we are in a final spurt up, over this week and maybe next.  Could get to SP1K in futures (unlikely to get that high in cash ie. daily market).  Yasi will feel emboldened when she should take profits and ride the drop.  Tonight's STU in contrast expects the market to rollover and drop tomorrow, perhaps after a short "squirt" to the upside.  Yasi will get anxious, but they see this as but a correction within a general uptrend of wave [2] towards Dow10K.  That correction most likely will play out as a trading range between the May8 high and around Dow8K, marking an X wave before a final zigzag up.  Yasi will be ok with that.  It might instead drop into Dow7K range, even down to the high 6000s, marking a larger B wave in a flat wave [2]; but if so should make a fairly sharp move downwards.  Yasi will be very anxious.  The good news is that this week should tell which it is: a final spurt, a trading range, or a nerve-racking drop.  Stay tuned. 

Investment Roadmap For Yasi

I have a colleague at work who is new the ways of the Force (technical analysis).  Freshly graduated and with a few shekels in her savings, she wants to explore the wonderful world of investing.  She is inundated with advice, all of it confusing and contradictory, and bless her good sense she wants to do her homework and work her way through it. I haven't yet had the heart to tell her it takes 10 years of dedication to begin to be a good investor, and even then the market will surprise more often than not. 

Instead I suggested she start with the easiest and one of the most effective investing system: the seasonal pattern promoted by Sy Harding.  His stats are on his blog, and he simply blows away the most common investing approach, buy and hold.  His system is perfect for Yasi.  She only has to make two decisions a year: when to buy in, in November; and when to get out, in May.  Sy even helps with his service, giving fairly tight windows for those decisions.  This year he called it right before the Nov21 bottom, and he hasn't given the 'go away in May' signal yet. 

Yasi is young, and eager, and has a full wallet; she doesn't want to wait until next November.  Instead she hungers for action, and is exploring what to do now.  Oh boy.  The best investment advice I ever heard was from Charlie Munger, partner to Warren Buffett.  He would tell young, eager investors to take out a postcard and fill in 20 lines.  Then he would explain that in their whole investment lifetime, they wouldn't fill out that postcard with good ideas worth investing in. 

But youth is impatient, and Yasi is not to be denied.  Now, as I have occasionally said about this blog, I do not give investment advice - especially not to a colleague at work, since she can find me when the advice goes wrong, as it usually will, or worse, her parents will find me.  Instead, I use this site to provide a perspective based on what other pundits are saying, plus what I can piece together from broader trends in the investor community and economy.

Thus, let me offer Yasi a perspective on major areas of investment, right now.  When you read this, Yasi, you should know that I have a number of very smart readers who have a deep and varied set of perspectives on the market.  They will be able to give you all sorts of advice.  I therefore would like to encourage readers to this blog to also give young Yasi their wisdom and perspective.

This is a long post, so you can read it all below, but for convenience I broke it up into sections, linked below.  Or, just go down the page.

Stocks

Bonds

Real Estate

Currencies

Commodities

Summary

Investment Roadmap: Stocks

In the short run, it is apparent we have some upside left.  If you had been reading this blog, you would have seen a discussion of When To Go In right before the Nov21 bottom, and another discussion of getting ready for the Obama Rally right before the Mar6 bottom.  After it ran up a bit, it broke out of its channel for the prior 20 months, signaling this was in a major rally.  Technical analysis points to a rally that should retrace at least 38-50% of the whole drop, and might go as far as 62%.  Right now two of the most bearish pundits both see a sharp rally.  Glen Neely Monday morning said he expects a 100 pt jump in the S&P.  Steve Hochberg of Bob Prechter's Short Term Update (STU) service Monday evening said he expects a strong rally to at least Dow9500 and SP1000. 

So jump in, right?