scriabin op 23

Gold From a Correlation Point Of View

noreply@blogger.com (Michael Krause) — Fri, 09 Sep 2011 16:39:00 +0000

Near term record high negative correlations between equities and gold. Looks like 2008 all over again.

If one looks closely at the data though, in 2008 the negative correlations peaked approximately a month before the Lehman event. On August 15th, 2008, the prior 50 trading day correlation hit -.59. At this point the S&P was still at approximately the 1200 area (before then plummeting to the 600s). When things really started to unravel, gold lost its magic touch as an effective hedge.

Swiss Devaluation Points To Similar Move For Yen

noreply@blogger.com (Michael Krause) — Tue, 06 Sep 2011 08:26:00 +0000

Per the SNB press release:

"With immediate effect, it will no longer tolerate a EUR/CHF exchange rate below the minimum rate of CHF 1.20. The SNB will enforce this minimum rate with the utmost determination and is prepared to buy foreign currency in unlimited quantities."

One can only wonder how fast a rate the Swiss National Bank will be accumulating foreign currencies with such a regime. Regardless, this points to signal the BOJ that such central bank policy is acceptable. I'd expect a similar move from the BOJ soon (should USDJPY of 85 be the target?). The immediate market reaction included a selloff in gold (now being bought back up). That reveals a bit concerning correlation traders' positioning (long CHF, long gold being the inverse hedge). Despite this, logically this is still a very supportive environment for gold. Fundamentally, a meaningful resolution (or capitulative conclusion) of the EU credit crisis will be likely the only near term threat to gold's ascent. Similarly, equity shorts unwound, but are now again falling. A Swiss Franc floor doesn't solve EU strife.

Gold indexed to 1913 CPI-indexed dollars

noreply@blogger.com (Michael Krause) — Tue, 06 Sep 2011 02:07:00 +0000

Not so cheap. Gold's purchasing power is at all time highs for everyone currently alive.

Gold bubble?

noreply@blogger.com (Michael Krause) — Thu, 27 Jan 2011 17:40:00 +0000

Usually in a bubble, investors are holding a bag.

Investors have been net sellers of about 100 tonnes in the last 7 months. The IMF has disposed of another few hundred tonnes. Yet gold price is higher by around 10% in the same period.

To put this into context, since December 21st alone, 2.2M ounces have been sold from the ETF, basically a bit more than an entire quarter of production from Barrick gold (the world's largest producer). The normal run rate of global recycling plus mine production is approximately 2.95M ounces per month. So in the same period, assuming GLD was the only source of outflow, total global absorbed gold supply was 5.15M ounces. If outflows continued at the current rate, the GLD ETF (the largest investor depository of gold by far) would have no gold in 18 months.

Supply increased 75% in the short term to see price only fall 4.5%.

Someone else is doing the buying, clearly.

Fed Funds Hike Expectations Update (December 2010)

noreply@blogger.com (Michael Krause) — Sat, 11 Dec 2010 15:25:00 +0000

I thought I'd go through the previous implied Fed Funds and Treasury 1 Year Forwards model and update it from August 14th, before QE2 policy was announced.
Here is a good cross section showing changes in expectations between then and today. So far, I'd say Bernanke has successfully steepened the yield curve, helping support future bank recapitalization. As well, it doesn't need to be stated (but I will anyway) inflation expectations are considerably different. That will obviously translate over to PPI and CPI in the coming months, given the recent commodity price moves.

And the number of rate hikes to expect in coming years, given market expectations derived from the yield curve:

Note: The horizontal axis is a date range of two years, with overlap per data point. The original model implied rate changes and rates starting at August 14th, 2010, whereas the second model is run 3 months later, so a slightly more accurate interpretation has December data square on 2011, 2012, etc whereas the original data represents August to August periods, starting August 2010-2011. Since this is framing a 30 year picture, I felt it would be unnecessary to reflect this 3 month offset. Imagine it if you need.

Home Supply Forecast (via New Home Sales)

noreply@blogger.com (Michael Krause) — Wed, 25 Aug 2010 21:58:00 +0000

Here is a long run look at population divided by number of annual home sales. From 1963 to 1995, there was a mean of 383.27 people in the US population per each new home built. Starting in 1995, the number dropped from 394 people per home to a record 229 people per home in 2005 (the building peak).

Assuming this population per production # is mean reverting, and the extra new housing supply was borrowed from future demand, it can be easily forecasted how much was overbuilt starting in 1996 and how long it will take for long run oversupply to return back to zero. This model establishes that new housing sales continue at the 2010 current average rate of 322K/year, and the US population grows 3 million people per year going forward. A netting out of long run oversupply does not occur until 2013. After 2013, new home sales should run at population divided by 383.27, assuming long run averages hold, or approximately 840K builds and sales per year at 2014.

These numbers generally concur with the yield curve forecasting a meaningful recovery starting in 2013-2014, as housing supply returns to long run balance.

Thoughts on Housing

noreply@blogger.com (Michael Krause) — Tue, 24 Aug 2010 19:47:00 +0000

Browse the web for today's financial news of "Existing home sales plunge 27%" and you'd think the world is ending.

It's not. This is simply a drop-off in transaction volume, and the news has already been telegraphed by falling agency debt rates. Average home prices are still 10% above 2010 lows, and just as in stocks, a fall-off in trading volumes do not mean the same thing as a price crash.

Common knowledge says tax credits catalyzed buyers to come out of the woodwork and move up the time-frame of purchase, borrowing future trading volumes into present periods. And as home transactions take longer and are done in much rarer frequency, it is likely volumes will remain anemic until enough time passes for the number of buyers to naturally replenish.

Granted, quantity traded is generally smaller on a higher price, so the volume numbers could be interpreted to convey lower prices lie ahead as the market re-equilibriates down in a post-tax-credit environment.

But expected returns on assets are in a nosedive, lending some countervailing support to asset prices. While 30 year treasury debt yields 3.57%, in local formerly overheated housing markets such as San Diego, even without being lucky enough to steal a discounted REO, one can easily buy entry level (under $200K) rental properties that yield 6-8% after expenses. In the mid range ($400-600K), yields hover closer to 4.5%-5%. It would make sense that these price ranges experience converging rental yields. On an indexed basis, a fall of the mid-ranged sectors may bring median prices down substantially, even if the low end strengthens (or holds up) considerably from here. In the face of a long run excess return of 350-400 basis points over treasuries with the added benefit of the asset being tangible and physically impervious to central bank monetary policy whims, the considerable value already in today's housing market can not be forgotten.

Given where risk-free yields are, there is no shortage of capital out there, and longer term arbitrage will continue to evolve all of these markets in better balance. Artificially higher pre-credit-expiration trading volumes in housing (almost an extra million units/year on an annualized basis) followed by a drop-off of similar magnitude (about minus a million units/year annualized) make sense. Given volumes were substantially elevated above norm for 3 months (September to November) out of 2009 and another 3 out of 2010 (March to May), it would make sense that we have up to 6 months (starting in July) of anemic volumes until normal trading demand returns. January 2011 should likely bring a return to the annual 5 million unit resale run rate.

Until then, lower than average agency debt supply (given that borrowers will have below-normal demand for new mortgages) combined with deflationary excitement means lower mortgage yields. Perhaps a 3.5% or 4% mortgage, provided by natural market forces, will be the perfect catalyst for the early round of 2011 home buyers.

Treasury Yield Curve Implications

noreply@blogger.com (Michael Krause) — Sat, 14 Aug 2010 22:49:00 +0000

Here is a derivation of implied 1 year forward rates on treasuries. A 1 year treasury forward is close enough (for government work) to get an idea of when the market projects the Fed will start moving rates upward. If you imply the Fed responds with hikes because a recovery is already happening, this data tells a little more where general sentiment is at.

For the sake of robustness, I purposefully designed this to work with very few input points, necessitating a basic a smoothing mechanism. From this, there is a small amount of error, but nothing meaningful.

The obvious interpretation here is that the treasury markets as of today do not project a meaningful recovery will start until 2012, with the end of cycle not happening until 2017. Post 2017, I'll venture to say 25 basis points of 1 year treasury forward movement per year is not actually projected Fed Funds policy change, but instead accounting for normal upward sloping yield curve behavior, where investors want to be paid extra for taking more interest rate risk from longer duration bonds.

The same analysis from a US treasury yield curve from November 1st, 2006:

Economics of Electric Cars

noreply@blogger.com (Michael Krause) — Sat, 17 Jul 2010 06:40:00 +0000

On the subject of the Nissan Leaf and its battery life, here is a spreadsheet I hope readers find helpful in deciding if it is economically viable to buy an electric car. Not included are differences in maintenance costs nor original purchase price. The intention of this spreadsheet is to decide if battery costs cancel out fuel savings benefits. Fill fields B3 to B16 to customize to your electric car's situation.

Click here to download.

Nissan Leaf Reservation Survey

noreply@blogger.com (Michael Krause) — Sat, 17 Jul 2010 02:18:00 +0000

Today Nissan released a survey to current reservation holders trying to assess their seriousness of demand, and more importantly trying to assess the impact various battery life warranties have on customer demand for the car.

Suspiciously, there was a particular focus on how the attractiveness of the car would change to me as a buyer (on the reservation list) if alternative of a 60K miles or 5 years were the primary battery warranty life (versus Chevy Volt's 100K miles or 8 year package). Also presented in this survey were questions focusing on how much I as a customer would be willing to pay to extend the warranty from both 5 to 8 years, and from 8 to 10 years (or 150K miles).

I have a feeling a little birdie in engineering is telling management anything past 5 years is going to end up costing the company a lot of money in replacing battery cells.

Australian resource tax: Impact on CLF

noreply@blogger.com (Michael Krause) — Tue, 04 May 2010 00:58:00 +0000

Impact of this tax hike on Australian miners on CLF (Cliff's Natural):

Right now, CLF revenues from Australia are 22% of total. After depreciation, cost of goods, and operating expenses, the percent of net income is approximately 17%. That is this quarter's reality.

Assuming Aussie net income was 20% of total net income going forward, a 40% tax on top of existing taxes (assuming this is a double tax) for the Australia segment raises the total effective tax rate of the company by about 560 basis points. A double-tax of 40% on top of 30% yields an effective tax rate of 58% for Australian profits. If it is merely a bump up from 30% to 40%, then the results are of course much more benign. Given a long-run US segment tax rate around 35% (just for simplicity), that would mean company wide effective tax rate goes from 34% -> 39.6%.

Now let's also say CLF net income equals $8/share going forward for the next twenty years, again for simplicity.

A 560 basis point effective tax increase company-wide would decrease that $8 EPS by $.68 a year. Since this starts two years forward, this has no impact immediately. Every year from year 3 to year 20 thereafter (I've just done 20 years in this model), the impact would be modeled at $.68/year.

The NPV impact would be $4.60 to the share price if the forward earnings were discounted at a 10% rate. The NPV impact would be $3.15 share if the forward earnings were discounted at a 15% rate.

In the event this proposal results not in a double tax, but instead is just a specific mining industry alteration to the corporate tax, then the impact equals .24/share annually. The present value total impact is equal from 1.12 to 1.64 (15% to 10% discount rate). Substantially less meaningful.

Today the share price fell $3.58 for CLF. Considering the proposal hasn't passed and the stock is now 20% off highs, it is safe to enter and likely a good buy. Taxes like this mean less supply in the long run, which is great for ore pricing worldwide in a growth scenario. But remarkable how efficient these markets are.

Click here for the Excel spreadsheet showing the derivation.

Do I replace my pool pump?

noreply@blogger.com (Michael Krause) — Sun, 28 Mar 2010 15:49:00 +0000

Geeky little finance exercise, off the beaten path. I am contemplating replacing my single speed leaking 1 horsepower pump with a Pentair Intelliflo VS-3050 variable speed pump which SDG&E will provide a $200 rebate for (on claims of energy efficiency). Why not apply some discounted cashflow analysis and probability of failure modeling to evaluate the viability of the project? For me, I can have the pump installed for several hundred dollars and don't need any rewiring my existing system. Your assumptions may be different.

One thing worried me of an online review I found: premature failure of pump drive electronics. The electronic drive part costs as much as a new pump. I made up a simple probability model of failure (so we could calculate an expected net present value to the project to take into account the risk of failure). I estimate 100% unsalvageable loss ascending with 10% probability on an annual basis (with a 20% failure rate starting the second year). These estimates are entirely a product of my own creativity based off real-life experience with electronic components. Often intuitive estimates are just as good (and useful) as rigorous statistical models. Maybe someone at Pentair can e-mail me real failure rate models for this component?

This model has everything factored in: warranty, cost of capital, energy savings, and even opportunity cost of replacement (not discounted as my opportunity cost may rise in the future). You can tweak it to your heart's desire. Any expected present value that is positive makes the project a go. With my energy savings and a 2% energy inflation rate, with zero failure the project has a 58% IRR after ten years. Even with a probability of failure being factored in, the IRR comes in at 40%. Not bad. I think I'll do the project.

40% expected return annualized. Maybe spread that with a short Japanese 30 year bond position? Talk about asymmetrical payoffs! If anyone has an idea how to replicate this into a hedge fund structure, let me know.

Download the model here.

STEC Valuation Model

noreply@blogger.com (Michael Krause) — Thu, 04 Mar 2010 22:17:00 +0000

Here is a model for STEC, known substantially as an enterprise SSD (flash drive) OEM provider. The model commences mid-2010 and starts with normalized revenues, attempting to the filter out of the false signals the large EMC contract sent to the equity price this past year.

Entirely adjustable to your own preference. Click here to download.

SIGM (Sigma Designs) Revenue Composition

noreply@blogger.com (Michael Krause) — Thu, 04 Mar 2010 22:03:00 +0000

An interesting component of equity analysis is revenue composition. Here is some quick work done on SIGM, showing the makeup of revenues substantially changing over time. This appears to be a company successfully diversifying away from concentrated exposure to one market, and may present an excellent value here, with non-GAAP earnings at .37. Normalize that over a year at .40/q, and you have a $16 stock with a generous 10 multiple. That of course is overly simplistic valuation analysis, but again the real story is in the unknown opportunities from a company that is aggressively expanding its product offerings, not the over-scrutinized IPTV segment. With a cash position of $4.79 and stock price in the low $12s, not a bad buy considering better revenue quality going forward. Other analysts who mention impending doom from Broadcom IPTV competition may be missing the point concerning the benefit of product mix diversification.

Click here for the spreadsheet.

The Yield Spike Everyone Is Expecting

noreply@blogger.com (Michael Krause) — Thu, 25 Feb 2010 19:07:00 +0000

Since everyone is expecting it, maybe it won't happen?

Any insecurity about the US government's imminent fundraising capacity should be resolved, now that the 7 year note auction is complete. While direct bidders (foreign central banks?) were a record part of the competitive bid (17.2%), US Treasury managers can sigh in relief that the hard part of the week is over.

This week's auction was a beneficiary of a massive amount of debt rolling off mid-February (recall Feb 15th is a maturity day), around $130B (of the $180B total raised). Which of course means marginal extra treasury supply was only around $50B. But that is a twice a year benefit, and by no means is the Treasury going to witness smooth sailing going forward, as we have an upcoming 10 and 30 year auction of substantial size without the liquidity benefit of old maturing debt to roll over.

When the Agency MBS quantitative easing program finishes at the end of March, it would not be surprising to see the market try to find a new value (higher rates) for agency debt (also likely substantially affecting other debt of longer duration). On the bright side, those who were itching to get out of their agency positions have now had sufficient opportunity to do so (for one full year amidst $1.25T of purchases). Perhaps that means Pimco has nothing substantial left to sell into the market. Regardless, like we are watching the market testing the Euro over this Greek debt crisis, it isn't a wild improbability that a yield spike, perhaps temporary, will also be witnessed.

After this yield adjustment occurs, perhaps the "free" markets will have a better feeling for what yield area is safe for entry into long maturity debt. Because of this, perhaps the direct bid percentage (of much recent concern) of these auctions will fall. Again, I am still suspicious there if there is enough capital out there to soak up US Treasury demand at these yield levels. Thoughts?

$180 Billion Fundraiser

noreply@blogger.com (Michael Krause) — Fri, 19 Feb 2010 14:14:00 +0000

Was the Fed discount rate move an attempt to show discipline in the face of record supply coming to the market?

$26B 3 month bills
$28B 6 month bills
$44B 2 year notes
$42B 5 year notes
$32B 7 year notes
$8B 30 year TIPS

$180B Fundraiser in one week (Feb 22nd-26th).

I am very suspicious of the 5-7 year auctions' performance.

Good luck.

Latent Chinese Demand, a Potential Cure-All

noreply@blogger.com (Michael Krause) — Sat, 23 Jan 2010 16:18:00 +0000

With the People's Bank of China starting to pull back liquidity, and talk of even higher RMB interest rates on the horizon, we may be at a turning point in world trade where a latent and underestimated potential source of global aggregate demand is activated.

Simply summarized, the past policy of the Chinese government has been to subsidize its exporters by devaluing its own currency. It does this by buying US dollars on foreign exchange with newly printed RMB to keep the currency rate generally pegged. Doing this aggressively over the past decade, it has built enormous world capacity and stimulated world demand for the goods it produces.

By China saying it wants to decrease the rate of money supply increase (by restricting loans and raising interest rates), it is communicating to the world an end of this RMB devaluation policy, necessary to maintain their US dollar foreign exchange peg. The Chinese central bank can't have lower RMB money supply and a maintained US dollar peg, unless of course they make an agreement with the Fed to also reduce its money supply simultaneously. In this political and economic environment, this is an impossibility.

The People's Bank of China has two policy choices. The first is they can keep up the status quo, printing RMB to buy US treasuries in order to continue to subsidize exporters, with the unwanted side effect of continued local price inflation and asset bubbles (real estate in particular). The alternative is that they raise interest rates and impose higher reserve requirements, reducing the rate of money growth. They have already embarked on this path, so there should be very little to guess (especially in the longer run) on where the RMB goes from here.

A stronger RMB means the US and Euro zone (China's largest trade partners) import less from China, while China imports more from the US and Euro zone. Such a change signifies a reversal of what many view a predatorial trade policy on the part of the Chinese. It also means the $2.4 trillion US dollars of accumulated reserves will have less buying power going forward.

In such a change, China's trade partners will have to deal with higher import prices, and will thus have lower GDP as a response. In the long run, their economies restructure and their exports increase (GDP rises). This reflects the J-curve model in international trade economics.

With China already the number one consumer of autos in the world, the Chinese consumer with the benefit of a strong currency would spell a voracious appetite for potential consumption. Certainly, with Chinese demand for transports growing at an exponential rate and global crude oil demand once again increasing, Chinese policymakers now have all the incentive in the world to let the RMB strengthen, keeping input and fuel costs under control, as global supplies of key commodities dwindle.

In the long run, a strong RMB means strong Chinese consumer demand, less price inflation in China, and increased exports (and thus economic growth) from the OECD. It also signifies a trend reversion of trade account deficits to possibly surplus, especially within the US. In a most extreme case where the Chinese government decided to sell off its stash of US dollar assets and then spend those dollars, a significant amount of latent aggregate demand is represented here. Contrary to Robert Samuelson's suggestion in Newsweek that "The massive disgorging of dollars could trigger another global economic collapse," it could in fact trigger quite the opposite, in the form of spending stimulus the US has never seen before. $2.4 Trillion US dollars represent an enormous amount of real economic activity, and any near term economic risk a short term rise in interest rates would more than be offset by the increase in US GDP, employment rates, and correlating rising government tax revenues.

Inevitably, there are many undealt with moving parts here, resulting in more questions. Post-RMB revaluation, will the new strong Chinese consumer offset the losses the former Chinese exporter suffers? Will the surge in Chinese consumer demand be a one-off event, as their exporters languish? Will the US and Eurozone, with now weaker currencies, be able to be competitive exporters with the side effect of increased commodity costs? How long will it take for the US economy to restructure back into increased manufacturing and other industries clearly destroyed by Chinese predatorial trade subsidies? With a future US having increased real GDP activity and better government fiscal status resulting from corresponding increased tax revenues, a stronger US dollar may be a long run effect, contrary to any near term movement against the RMB.

The only near term certainty is that such a significant policy change will create volatility and result in enormous real economic change. An overshoot weakening of the US dollar would be likely. As well, gold may do well and US treasuries may suffer (as a significant buyer disappears from the market). Furthermore, since significant structural changes would need to occur in the US economy to adjust to a strong RMB, it may take a long time for exporters to adjust. This points to a lag in increased tax revenues. Short term, with a dollar devaluation, notional value of imports would increase, putting negative pressure on US GDP and making the US fiscal condition look all the more dire.

Inevitably, policymakers might invoke accelerated money printing and fiscal stimulus to ease the pain. Uncertainty may drive up inflation expectations as well, increasing the likelyhood of higher long run interest rates. Such an inflationary move in the US may be just what the doctor ordered, as nominal wages rise and accumulated debts currently stifling lending (reflecting bank insolvency) would be rendered non-issue.

My three favorite instruments

noreply@blogger.com (Michael Krause) — Fri, 08 Jan 2010 13:53:00 +0000

Gold, Japanese Yen (particularly against the dollar), and Treasuries.

I'm endlessly fascinated with this trio, and here are some latest thoughts after much belation. Today with a worse than expected jobs report, confirming a job market still in contraction after 2 years, the most notable market reaction is not in the treasury market, but the gold market. I can personally testify to the looseness of the job market here, being a somewhat discouraged job hunter right now (hint to all portfolio managers in San Diego).

Right now up about $15 off intraday lows, gold strength now reflects the general diagnosis that policy makers will resort to money printing and continuation of low Fed Funds in order to architect a meaningful and convincing recovery. I might even go out on a reach and say it is turning into a negative beta or at least low correlation asset to the S&P (S&P down, gold up), making it more desirable to portfolio managers even at these high levels. Will post updated model to confirm or deny this.

I've suspected for awhile that immediate substantial pressure on gold stocks (down 20%+ versus gold down 8%) versus outright gold bullion came from portfolio managers wanting as neutral a position as possible, going short the high beta gold stocks in combination with long lower beta gold, pricing the market out of their gold exposure. Of course, there is enormous operating leverage in gold stocks, and this neutral positioning may not do well in the case gold moves substantially. A model I've prepared shows Barrick gold price quadrupling if the price of gold rose 77%, holding input costs constant. This is just as if not more likely to explain the falloff. But it does not explain the relative longer term underperformance of the entire gold patch. More on these thoughts in another post.

Then the Japanese yen against the dollar, really my favorite position as of late. This bottomed recently around 85 yen to the dollar, and has shown continued strength ever since the Bank of Japan announced their easing program. Yesterday flying through the 93.10 mark on new Finance minister remarks attempting to talk up the dollar, it appeared this is a trend worth being a part of. My reasons for interest in being long the dollar against the yen have more to do with a belief that much like the US, the Japanese will have to increasingly resort to debt monetization to offset government deficits catalyzed by a lagging economy, correlated lower tax revenues, and most importantly a population demographic change leaving a shortage of demand for Japanese debt at absurdly low levels. Not an original idea, I envision trade against the Yen and even short the Japanese government debt will be an immense opportunity, and a giant macro game-changer as far as world trade is concerned. Imagine the changes to global trade implied by a 200 yen to the dollar exchange rate. Perhaps the best long term position idea is short yen versus gold or silver.

Onto US treasuries. Some $2T of debt will come to the market this year, and the duration of new issuance will likely increase. This means higher interest rates assuming the lending picture does not change considerably. If lending ramps up, that means more bank created money supply to finance the purchase of some of this debt. It's difficult to reconcile any dramatic movement either way, but those supply numbers are scary. Until issuance numbers start dropping off, treasuries will be under pressure unless yields move up. Today's interesting movement is the continued muted reaction (dead) in the long end, with increased inflation expectations trumping fear of outright economic collapse. Thus, gold doing better than bonds (from pre-report levels). Of notice is the strong dollar selloff today in contrast to a half a point upward movement in the 20 year future. In real terms, treasuries are stationary or even down on this news.

Dispelling Recent Fed Funds "Myths"

noreply@blogger.com (Michael Krause) — Sun, 01 Nov 2009 19:20:00 +0000

I'm following chatter of media and friends about the imminent doom that may come from Fed Funds rates increases, and that the market perceives a higher chance that the Fed pull away from zero interest rate policy soon. First, 2 Fed Funds charts showing no evidence the market perceives a risk that the Fed changes its policy near term. In fact, quite the opposite, bets are being put on that support extension of zero interest rates. The past 2 weeks have most definitely seen increased expectations for lengthening of current policy.

March 2010 Fed Funds contract:

And January 2011 Fed Funds contract. Remember, the higher this goes, the lower the interest rates. 98.80 means expectation of a 1.2% effective fed funds. 95.00 would mean an expectation of 5% fed funds.

Now to the piece of "common sense" that says the market would fall when Fed stimulus reverses course. First, from a history of 1954 to present, with blue areas showing periods of rising interest rates. Followed by a 1970 to present snapshot (more relevant data set perhaps).

And 1970 to present:

To me, Fed hiking looks more like a bullish signal and Fed loosening is more unpredictable (for good reason, as it responds to contractionary periods). It almost seems like there is a conspiracy in the media to get people to sell this move up. Maybe that's a silly and paranoid presumption. Right?

Morning Thoughts on Yen, US Treasuries.

noreply@blogger.com (Michael Krause) — Tue, 27 Oct 2009 11:45:00 +0000

Thoughts on yields and the dollar from here (from a forum post on a site called elitetrader.com I made this morning):

They (US treasury bond investors) take 4.37% on the 30 yr treasury because both inflation expectation and the amount of money supply out there for 'investment' justifies it. As long as the banking system continues to be a vortex that makes a huge sucking sound, investment dollars will support treasuries.

M2 has done next to nothing all year, which tells me the word on the street that this is "liquidity driven" is probably not a function of "new liquidity" as much as its a function of investment outflows of late 08 (and early 09) just reversing. A one time event.

The Fed has another few hundred B of MBS to go, so I think M2/M3 may still have an upward catalyst if current lending styles were held constant.

That said, if inflation expectations remain grounded (which may happen as long as the Fed has policies that disencourage lending), the combination of more money printing (and wages from deficit government spending) might just be supportive of the long end more than the common gospel expects.

Look at the Japanese: their public doesn't believe the economy will ever take off, so they bid the 30 yr to 2.2%. If you want to short a country on this prognosis, I see only one reason why the US bond short could be a better call, and its a stretch: the Japanese might feel 'duty' to buy their government bonds to be supportive of their own government's status quo... But I highly doubt that - in the end, fear runs the day and it won't continue. Like Einhorn says, their fiscal problems make our worries look premature.

The unintended consequences of the Fed's policy to directly control lending are likely to surprise.... the new normal will be a large base money and a smaller multiplier, at least until banks have no more losses to write off and reserves to build (2-3 yrs?). And we should be thrilled our debt is externally held by China and Japan: we pay high enough yield and it is still denominated in dollars. It is when our debt is denominated in foreign currency when it becomes dangerous to us (lessons of southeast asian crisis amongst many). I'd be more concerned about Japanese debt, as their debt isn't attractive enough to be held by anyone else but those with duty (Japanese). They are way closer to the breaking point than the US. I see 'revenue growth' on the US government's balance sheet as we get some kind of recovery that results from return of economic faith + increased base money flying around (even holding taxes constant today). That will add some credibility to support more debt issuance at relatively low yields.

I think buying USDJPY is the best trade here, where short treasuries is even more a hero trade (if you're right, you'll make 30-50% sure, but you could've made that in one day in Amazon or some derivative of something else with considerably higher probability)... Maybe buy some gold, but if you bet treasuries go down, just know you are betting on banks ramping up lending significantly. Without the banks, treasuries stay relatively close to where they are. And if I'm wrong, it is only in the condition of a concurrent USD collapse (again I'd bet on a JPY collapse before a USD collapse).

Natural Gas ETF vs Chesapeake (and any producers)

noreply@blogger.com (Michael Krause) — Wed, 16 Sep 2009 04:11:00 +0000

An interesting trade idea: Buy puts on the natural gas producers and calls on the natural gas tracker ETF UNG. This is very against any long term investing position I'd normally consider in the natural gas sector, since UNG has cost of carry and contango effects to deal with. But now may present a time window to take the opposite side of "common sense."

By the chart above, natural gas appears to have technically put in a bottom. As painful as the 15 or so month gas bear market has been, I have a hard time believing the "recovery" will be a pitiful few days. Of course, this might be a headfake since the fundamentals are still relatively lousy (despite being so well known). The announcement of the UNG ETF expansion alongside with increased transparency in CFTC COT reports have certainly helped the bullish case for natural gas. Regardless, contango is wide enough between the front months that those spreads have room to continue to close in. If they do, the UNG and any natural gas front month tracker will likely do well.

At the same time, the fundamentals of a natural gas producer stock are different, since they are priced off of future earnings of production as well as today's. A producer such as Chesapeake (CHK) is in the mid-28 price range, whereas 2 months ago it was in the 17s. That is a 65% price recovery.

During that same recovery period, a distant natural gas contract such as December 2010 has oscillated minimally in the 6-7 range. The trade here is based off the idea that CHK should be priced to longer term expectations of the natural gas market, not merely the whims of what is happening to today's gas. An earnings stream of 5 years of gas at $2.00 this year and $6.00 the following four years justifies reducing the relevance of the front month's volatility to a producer stock's price.

For context of long dated December 2010 gas (relatively unchanged) versus a producer like CHK (shown above):

Even Chesapeake's 27% move up during the last two weeks was accompanied by much less fireworks in the long dated gas. Clearly, there is multiple expansion and/or economic recovery getting priced into the broad equities market. This is of course affecting Chesapeake and other gas producers, probably explaining the bulk of this move (as opposed to natural gas price).

In the end, the fundamentals reign. If front month gas continues to move exuberantly, UNG (and CHK) will benefit. Entering this long UNG call / long CHK put trade is a limited exposure long natural gas play, one especially valuable in an already generally long equities portfolio. If equities decide to reverse, the portfolio will have some negative coverage in an already extended natural gas sector.

JPY to Crude Correlation

noreply@blogger.com (Michael Krause) — Fri, 21 Aug 2009 18:26:00 +0000

A high correlation (1) means people are buying JPY (selling USD) and crude coincidentally (or selling both simultaneously [which implies a universally strong dollar]) Interestingly enough, since usually heavy buying of JPY occurs in a derisking context, this is contrary to what one would expect to happen of the "weak dollar / strong crude" trade. Derisking has lately meant a stronger Yen and a cheaper oil price (implying strong dollar), seemingly contrary dollar movements.

Of considerable interest is the September 08 swing from positive correlation to negative. It is difficult to decipher any clear buy/sell signal for crude out of this, as the correlation oscillates frequently. Lately, though, a negative correlation has coincided with downward crude movement.

It reminds us that crude is not anything close to a pure proxy for short dollar in the short term, and its own supply/demand dynamics largely dominate at times.

Fear Trade Correlations

noreply@blogger.com (Michael Krause) — Mon, 17 Aug 2009 15:31:00 +0000

Here are some correlations of popular fear trades with equities as a backdrop.

Know What You're Buying: Correlations (Gold Vs S&P)

noreply@blogger.com (Michael Krause) — Mon, 17 Aug 2009 14:51:00 +0000

It's been a while since I've posted to the blog, but I have a feeling my dry period of creativity is over. Keep your eyes open.

From here, I'm going to start posting correlations of varying instruments. For short term trading, it is important to know these things and how they change. These are rolling 30 day averages on daily correlations in changes of close. If you have any particular instruments you are interested in, let me know and I'll post them. If you aren't familiar with correlation, a value of 1 is 100% positive correlation and -1 is 100% negative correlation. A value of 0 means the instruments' daily motions have little to do with each other.

Let's start today with S&P and Gold:

Japan Vs US on Quant Easing

noreply@blogger.com (Michael Krause) — Sun, 31 May 2009 16:45:00 +0000