MARKET THOUGHTS

THE AFRICAN RENAISSANCE

2010-03-25T10:43:00.006-04:00

Admittedly, I am conflicted about the title of this post. I am not sure if what is taking place on the African continent can be characterized as a Renaissance or an Emergence. Whatever it is, there is no denying the fact there are some good things happening there. You need not look any further than countries like Botswana, Angola, Ghana, Rwanda, and even Nigeria, to see evidence of this. I remember telling a group of friends, back in 2004, that the greatest economic opportunities of the 21st Century will be found on the African continent. Of course, I was met with great skepticism but that was understandable especially when you consider the fact that I used the superlative "greatest". I am not the type of person who usually uses hyperbole and superlatives. Africa's problem has always been, and continues to be, that of poor governance. The majority of the countries on the continent have been beset by a crop of leaders who, for one reason or another, just can't get it right. Not withstanding the corruption and the meddling by former colonial masters, Africa's problems have always been essentially one of poor leadership.

Opportunities

So where are the opportunities in all this? Well we can start by meeting the needs of it's more than 500 million people. You see, the needs of the people are growing and this is due largely to the influence of countries like China (and India and Brazil to a lesser extent) which has made no secret of it's plans to cement relationships with African countries in order to secure the commodities it needs in order to sustain growth. The result is that the participating African governments have found a new market for their natural resources and a willing, and politically indifferent, partner in their development initiatives. This of course is one obvious and undeniable reason for the kind of growth we are seeing in some African countries. A second, and far less obvious yet many times more important, reason is the renewed sense of being and belonging that has emerged in African Cultural and Economic discourse. In fact, the common refrain is that "if nations like China and India can emerge from Economic obscurity and lead the world in various industries then why can't we?" Even corrupt leaders and Warlords are now realizing that the real power and wealth, that they crave so much,are no longer to be found in Jungle Warfare or by ruling over dilapidated cities and pillaging a demoralized citizenry but in the board rooms and among the shareholders of fast growing African conglomerates. The bottom line is that Africans want what the rest of the world has and they now have, at least by the level of discourse, the will to get it. They want modern telecommunications, Infrastructure, Financial Services, Health Care and Education. To get a better picture of what the opportunities are like, just think of America in 1918 or China in 1981. The fact is that the amount and quality of the Infrastructure, telecommunications etc that exist there today are so few and of such a poor quality that it will take decades to build out and as one or two countries get it right it will spread throughout the continent like a virus. Just look at Rwanda and neighboring Congo. Rwanda's thrust into Telecoms and the Internet has transformed that country, from what it was as recently as 1994,to a leader in the ICT industry in Africa. Rwanda's success has sparked a similar drive in the Congo especially along the border shared by both countries. So? do you see the opportunities?

Early Days Yet

Of course it is not easy for the normal everyday investor to take advantage of these opportunities. After all, we haven't the resources or expertise to Joint Venture with an African government or to start up a Private Equity Fund. But there are tons of Funds and Funds of Funds, of varying qualities, available to retail investors who want to be a part of the African Emergence. We should note, however, that this is no panacea. There are still serious problems there and it will take a long tome to solve them, but as far as opportunities go,the age old principle of creating wealth/making money by meeting a need or solving a problem holds strong and firm in Africa where the needs and the problems are numerous.

P.S: Here is an excellent video of a TED talk (I love TED) about Africa's opportunities. It was presented in 2007, that's 3 years after I made my "Greatest Opportunity" claim.

The Four Pillars

2010-03-03T15:34:00.003-05:00

I was asked by a friend to state what I thought were the pre-requisites for a country to be prosperous ( the general conversation was about the Caribbean and Jamaica in particular). Without hesitating I listed four things: 1) Education 2) Health care 3) Infrastructure and 4) The Rule of Law. For years I had asked myself the same question and these are the things which kept coming back again and again. Now these four thing, by themselves, will not necessarily make a country prosperous but they will set the foundation for growth. The fact is that without these four things, no amount of fiscal and monetary policy, export strategy or anything else will make sense as they will only benefit a few people, and no country can grow in real terms if only a handful of people have the capacity to produce and consume.

A Brief Look At The Pillars

Education & Health care: education and health care are in recognition of the fact that Human Capital is the best resource of any nation. Forgive the cliche but it is just a fact. AN educated and healthy populace are far more valuable than 10 billion barrels of oil in the ground. Just compare Sweden to Nigeria. Need I say more?
Infrastructure: Access to reliable and affordable water and electric power, as well as transportation systems are absolutely essential. Without these, any effort to mobilize the labor force and try to encourage production will be an exercise in futility.
The Rule of Law: this acts as an "invisible enforcer" so to speak. Everyone knows what the consequences of their actions will be and it engenders stability because the citizens,and anyone looking to invest, can plan and execute based on the protection of the law.

Necessary Pillars

If you take a look at any country that has not been able to grow/develop you will find that all, a few, or even just one of the four pillars are missing. I challenge you to find one exception. It is interesting to note that even if you look at nations in economic decline, such as Spain or Portugal, you will find that the pillars are being eroded or simply neglected due to poor governance. These four pillars are so essential that in any nation or any situation where there is the mere appearance or hint of a government implementing the four pillars you will see foreign investment begin to poor in. Two examples stand out, China in the last decade and up to now ( even though we now know that the rule of law is a shady area) and Brazil up to this point.

What the Pillars are Set Upon

Of course, as I told my friend at the end of our conversation, it takes good governance to execute these things. So at the end of the day, it starts with good governance. It Always does, and always will.

Death of the Proprietary Program

2010-03-03T15:13:00.005-05:00

Well it is not dead but it is in a very deep sleep. Financial and time constraints and a disagreement with a hired programmer have caused me to rethink the trading program I was building. So while I think, it will sleep. I proved that the power of the program was its simplicity. It was built on four very basic variables/indicators and one principle (yes principles are programmable). But alas I am unable to take it to the next level right now. So it will rest until I can. Besides, my passion for short term trading was waning. You see, I am a macro guy. I like the big picture and I see enormous opportunities on the macro level going forward but my program was not built to track or trade macro events. So this will be part of the rethinking. I will try to see if I can marshall the resources to build a first class macro program. One that can take advantage of macro trends. So as I said, the program will sleep while I think.

Best Forex Software Designed For Unfailing Profits

2009-07-30T14:32:00.001-04:00

Best Forex Software Designed For Unfailing Profits

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12 months!

2009-03-30T22:02:00.002-04:00

Exhilarating!!!

Personally and professionally I have experienced things I never dreamt I would ever experience. The lessons learnt over these last twelve months are numerous and priceless. The events that have unfolded in the financial markets, and by extension, the economy have been absolutely amazing. We witnessed volatility on a scale never before seen as the global economy came very close to imploding. The volatility has subsided somewhat, but it doesn’t mean we are out of the woods and it certainly doesn’t mean that the threat of a global financial meltdown has abated. I keep getting questions about what caused all this. That, I think, is a subject that has been adequately aired by now so I will not go into too much detail. In fact, I scarcely think there is anyone who has been paying at least scant attention who does not know about the collapse of the housing market (a subject I addressed in a previous article here) and the leveraged risks that were taken by some players in the financial sector who really should have known better.

The Genesis of the Crisis In 4 Stages

1) Briefly put, various debts such as mortgages, student loans etc were packaged by financial institutions and sold off as securities to just about anybody who would buy them for the attractive yield. In the case of mortgages (which is often cited as the real problem), both good loans (people who could afford to pay their mortgages and had good credit) were packaged with bad loans (so called subprime borrowers or people who were likely to default). When the actual debt holders started to default on their debt (like Jane Doe in my previous post) the instruments that were sold as investments became worthless.

2) The problem was that these instruments were sold far and wide and ended up on the books of just about every major financial institution, pension fund, and municipality in the world. So when the defaults were triggered it cascaded and forced everyone holding them to take huge write downs on their assets. Think about this, if you bought bonds that were worth 10 million dollars (backed by the value of the houses and the homeowners promise to pay a mortgage) and the value of the houses fell, as they did, and the ability of the homeowners to pay the mortgage became severely impaired- then its obvious those bonds were no longer worth 10 million dollars right?

3) It gets even worse when you consider the fact that the institutions or entities who held these bonds, in many instances, borrowed huge sums of money using the bonds as collateral. So, naturally, when the bonds fell in value those loans were called in. Of course they were some companies (Bear Stearns (BSC) and Lehman Brothers (LEH): may they rest in peace) and many others that could not pay up and simply went out of business. This ripped through whatever remaining confidence there was in the global credit markets as no one was willing to lend to anyone when they didn’t know their level of exposure to these bonds.

4) Needless to say, this dried up the flow of money (credit) from those who had it to those who needed it. In fact the share prices of companies who depend on credit to finance and operate their businesses fell significantly and since a large percentage of publicly listed companies do operate on significant credit (corporate debt) the overall effect was the Stock Market Crash. This is what happened to the likes of General Motors (GM) and General Electric (GE) and countless others when it became apparent that their inability to secure financing and run their operations would hurt the bottom line. And from all indications, many more will follow.

Ok. So what’s Next?

Well once you understand that what we have is crisis of confidence in the Global Credit Markets (that’s where it started) and the way the world governments are trying to deal with the problem then you can pretty much see what is likely to result form this. In my humble opinion, the next phase of this crisis is inflation. Maybe even hyperinflation. How is this? The governments of the world have sought to deal with this problem by cutting interest rates and pumping large sums of money to prop up the debt markets and boost liquidity. Remember that private institutions are not lending to each other because the risks are still unknown and undefined. So what the central banks are doing is pumping money into the system and hoping that the supply of money will reach a level where the banks (outlets) have no choice but to start lending to each other and the general population again. It is that simple. There are many financial strategists and so called “market mavens” who believe that this action by the government signals a turning point in the markets and that the worst of the credit crunch is behind us. I, on the other hand, think that it signals the possibility of worse to come and I will tell you why.

Let’s look at the US government for instance. They have made it clear that they will try to put a halt to the decline in the economy. The reasoning here is that when there is sufficient credit, the companies and individuals can borrow to produce and purchase goods and services which will lead to growth. This, for the most part, is true. For this job they have only two tools: fiscal policy (budget and taxes) and monetary policy (interest rates and money supply). They have been using the latter. To date, more than ten trillion dollars have been pumped into the economy through various channels to prop up the debt markets and bailout various financial institutions. Just take a look for your self:

Source: mises.org

This is a chart of the growth in the money supply in the US. The money that the government is printing is being added to the stock of green backs floating around out there and money, just like any other commodity, gets less valuable when there is too much of it floating around or when there is no meaningful production to underpin it. We know there is too much out there because the growth of the money supply outpaces the rate of production of goods and services and that is where inflation is born (a subject I addressed in a previous article). Since it’s obvious that Uncle Sam is likely to persist, then further inflationary pressures in the economy are inevitable. Simply put, this means a weaker US dollar, costlier food, higher fuel prices, and just a general higher cost of living for you and yours. Not trying to scare you. Just telling you the truth.

A Pause For A Cause

I am affiliated with a small and dynamic software and web development company (Director & Shareholder: for full disclosure) They have created and are testing a toolbar that delivers Jamaican content. I have been using it and find the streaming news and access to hundreds of free radio stations to be quite useful. In fact it has a feature where you can search for live streaming radio stations by genre. It is very small and fits perfectly and seamlessly on your browser window. Ultimately, it will be a portal to Jamaican news, sport, business entertainment etc. And, we hope, a powerful advertising tool. As I said it is in Beta so there are still a few kinks. You can download it here:
http://jalive.ourtoolbar.com/

Only for Those of You Who Are So Inclined

I know that not all my readers share my passion for the financial markets, so this next segment is for my fellow aficionados.

I have spent a tremendous amount of time over the last year studying Economic Cycles Theory and Mean Reversion. My primary reason for studying these things is to make money. It’s that simple. In fact I am currently building a trading program that is primarily based on the concept of Mean Reversion. It is something I started about two years ago and initially tried working with programmers and software developers to get it going. That failed miserably. I put it aside for a while and then returned to it about 7 months ago. I committed myself to learning basic programming language (Excel BVA, R and C++). These long hours have cost me dearly in just about every way (relationships, money and even my eyesight LOL) but the program seems to be working.
However, I see this as an investment in the future and whoever/whomever was wronged or felt slighted because I spent so much time and money developing this program should know that this is a necessary sacrifice and expect that all will be made right in the not so distant future ): . I am currently back testing and running simulated trades with pretty decent results so far. I found the things I learned studying these concepts to be quite fascinating. In fact I would go as far as to say life changing. The application of these concepts goes way beyond trading futures and options. I will give you a basic definition, share with you what I learnt and pose my conclusion.

1) Program trading: This is basically computer driven automatic trades. The value of a well written program trade sequence is that it effectively strips out human judgment and emotion from the decision making process and the trade execution. Add to that the speed with which it analyses data and does computations and you can appreciate the usefulness of such a thing in today’s volatile markets.

2) Mean Reversion: Is the concept that all securities have an average price at which they trade over different time frames and that any divergence from this mean, whether up or down will eventually be corrected. I know some might be asking: is this not what the RSI does? The answer is NO. I have compared the two in real time. They are like night and day. I now realize why I lost money using RSI. LOL. My program is built to 1)calculate the mean over various time frames for a given security 2) give a signal when a security is in extreme divergence and 3) confirm divergence with other technical indicators. The next stage of development is to have it fire off a trade, upon confirmation, based on certain entry and exit parameters. The thing eats memory as it has to constantly store data and continuously calculate the mean (in short time frames). But it is a thrill to watch it crank out numbers and signals and know that each is potentially profitable.

Some Things I learnt

I learnt that the conditions have to exist for reversion to take place. For instance in short term trading (shorter time frames) the demand/supply balance in terms of the available units of a security (stocks, option/futures contracts etc.) has to be severely skewed, and that technical tools rule the day. In this day and age plain vanilla technical tools won’t do, we are talking about far more advanced TA tools. On the other hand, over the longer term, the fundamentals dictate to the market/asset class that it is time to revert.

Ø To put the previous thought in context, let’s look at the financials vs. commodities in today’s market environment. For financial stocks the fundamentals indicate that there is more trouble ahead, so even though my program is showing extreme divergence levels and a high probability trade set up, the fundamentals are saying that there will be no meaningful reversion anytime soon. You see, the program is not aware of the situation in the credit markets as it was not a variable that was written in its code. It only knows today’s price action relative to previous price action. The commodities on the other hand pose a more likely trade. For instance, we know that we might very well see a spike in inflation in the medium term which is usually good for commodities. The program doesn’t know this, but it knows that the Oil ETF, USO, is in extreme divergence. In fact the program reveals a mean price of $64.05 over the life of the ETF and now it trades at around $28. A simple reversion to the mean would bring a $36 profit. For this trade I would go long call options with a distant strike. It is actually a trade I am looking at now. Of course every trade should be hedged (because black swans aren’t that rare these days). That I have to do old school discretionary style because my program has not “learnt” hedging yet.

Ø I also learnt that program trading is VERY influential in short term market activity. In fact if you trade short term and ignore or strip out the program trading factor, you are making a big mistake. Program trading moves a significant amount of the volume on exchanges all over the world everyday. One statistic I saw said program trading could account for as much as 50% of all transactions in the next decade. The programs being used today are very powerful, they are programmed with multiple variables (unlike my binary variable simpleton) and are capable of generating signals and firing off millions of trades in a fraction of a second. Talk about swimming with sharks. The future for short term trading is program trading.

The Most Important lessons

The most important lessons I learnt is that everything operates in cycles and that there are cycles in everything. There is a pattern that life forms on earth have followed from day one and continue to do so. And since the cycle, by its very definition includes a top and a bottom, mankind and just about everything else continuously fluctuates around the mean, the average, the so called equilibrium. And any extreme divergence from the mean WILL correct itself. When the economy overheats and grows too fast we have fall outs like the one we are having now. When it sinks too far in a depression we have tremendous growth spurts like that experienced after WWII to around 2002. Understanding these things has really helped me understand what is going on today. My tentative conclusion (since I am still studying) is that mankind’s mean is rest. We are born. We live. We die. By virtue of the fact that we spend far more time at rest (the avg. human lives to about 72) suggests that our mean, to which we must revert, is at rest (death). My conclusions may yet change but it certainly gives me something to think about. I hope it does the same for you.

What Housing Recovery?

2008-03-30T04:46:00.000-04:00

*Please click on the title of this article to see a chart showing the decline in the Housing Market.

There has been a lot of talk in financial circles about whether or not we have seen the end of the fallout in the housing market. However, recent data suggests that house prices continue to decline and foreclosures are increasing. The Case-Schiller Housing Index, released on March 25, which tracks the twenty major US cities and suburbs, showed that house prices declined 10.7% compared to the same period last year. Interestingly, for the first time, the index revealed decreases in every metro area except Charlotte, NC. Therefore, it would seem to me that any talk about a full recovery and stabilization of house prices is premature at best and suggests a sort of irrational optimism. At this point there is more than enough evidence to suggest that we have only scratched the surface and things are liklely to get a lot worse before they get better. So, if you were a home owner in Charlotte NC would you be breathing a sigh of relief and thanking the heavens that you have been spared? or would you be bracing for the impact?

Foreclosure and You

I was recently asked by a reader to make the link between foreclosures and the nationwide fall in home prices. She did not quite understand why her property value would fall or why she could possibly end up losing her home because her neighbors lost their home through foreclosure; especially when she always paid her mortgage on time and in full. I find that the answer is more easily understood if it is framed outside the normal economic theory. So, consider the following scenario: Jane Doe lives on a quiet cul-de-sac in a middle class neighborhood. There are ten houses on her street, and of those ten houses she was the only one able to get a 30yr fixed rate mortgage because of her good credit and her job situation. Her nine neighbors, however, had a credit history of a lesser quality and as a result they had to accept mortgages at rates that were adjustable and tied to various terms that would see their mortgage rates go up significantly if they were late or missed a payment. Four of Jane’s nine neighbors started missing mortgage payments because they lost their jobs at a plant down the street when management outsourced most of the work to China. Then a fifth and sixth neighbor started missing payments for other reasons.
With unpaid mortgage debts piling up and no apparent hope of repayment the Bank has no choice but to repossess the houses and evict Jane’s neighbors. Now follow closely: The bank now has the homes of Jane’s neighbors and countless others on its balance sheets. These homes are earning nothing for the bank because there are no rents or mortgages forthcoming and besides that, the homes are deteriorating structurally due to lack of maintenance. The bank decides to get rid of these homes as fast as possible and cut its losses by selling the homes at “fire sale prices” usually close to half their original value. Bear in mind that Jane bought her house for $400,000 three years prior and after she bought the house she took out a $100,000 home equity loan from a second lender to purchase furnishings, do minor renovations and payoff student loans.
Now Jane realizes that she lives on a street where the average home sells for $275,000 and is faced with the reality that there is no way she could demand upwards of $400,000 for her home in a market where the average price is almost half of that. Her home value is cut in half through no fault of her own. It doesn’t stop there either: Remember that Jane had taken out a loan using the equity in her home as collateral. The decrease in the value of the property has all but wiped out the equity and now the terms of her loan are in question when her lender realizes that Jane has no equity left and, as such, has violated the contract terms of her loan. Her lender immediately demands payment of the remainder of the loan in full. She does not have the means to pay off the loan and tries to negotiate with her lender who notifies her that the only way for them to proceed is to increase the interest rate on the remainder of her loan in order to compensate for the risks associated with the declining value of the asset. Jane now has a higher monthly payment on her home equity loan and still has to pay a mortgage on a home which has declined significantly in value. It isn’t long before she starts to buckle under the increased expense, especially in light of the fact that her income has not increased. She misses a couple of payments and goes into default and her home is foreclosed by her first mortgagor.

Opportunity and Chaos

I admit that the scenario is somewhat of an over simplification because it is hardly likely that home values would decline that steeply or that our Jane Doe would be treated that harshly given her good credit standing. But I think the point was made. That being said, I would like to point out that the Chinese symbols for the words “chaos” and “opportunity” are one and the same. Of course the concept has become somewhat cliché over the last couple of months as the mainstream press and various pundits keep insisting that it is a buyers market as far as residential real estate is concerned. Well, I have a different view. While house prices are significantly lower than they were as recently as six months ago, it does not necessarily mean that it is a bargain, especially when you consider that prices could fall further. For instance, if we simply extrapolate the events that took place in Jane Doe’s neighborhood to her entire suburb, her county and her state we could get a picture of how, what is now known as the “housing crisis” ,has been spreading and could continue to spread.
The really interesting thing about this situation is that it feeds on itself because the increasing numbers of foreclosed properties that come on to the market increases the overall supply-and without ready buyers- the prices will just continue to trend down. It is basic supply and demand theory, it is a true constant and NEVER changes. Now, I do believe that there is plenty of opportunity in chaos but the extent to which one is able to exploit the opportunity is largely dependent upon ones ability to know where the chaos stops and where the opportunity begins. The bottom line is that one ought to be careful that one does not catch a falling knife in an attempt to catch a bargain. It is not at all inconceivable that you could purchase property today at perceived bargain basement prices and see a further 30-40% wiped off the value before it begins to turn upwards. There are players in the market who thought they found their “opportunity in chaos” in California and Florida in September 2006. House prices in these two markets (the worst hit so far) have declined significantly since then and still have further to go.

The Bottom of the Housing Market

I will end this conversation where I started: ignoring the pronouncements of recovery. I am not saying that I know where the bottom/turning point in the housing market will occur. If I did I wouldn’t tell you. Or maybe I would tell you after I have secured my positions so you could come in, with the rest of the herd, and push my asset values through the roof. However, if I were to guess I would say that the turning point will come when no one is interested in buying, when you literally have to give it away if you want to get rid of it. At least, historically that is when markets tend to turn. And as they say- history repeats itself. But quite frankly, I do not believe this will hold true because things are a lot different this time. In fact I would go as far as to say that it is unlike anything any scholar of Political Economic history has ever seen. For one thing it does not appear to be a mere correction in the real estate market. The instability is showing up in just about every asset class. Many long held views, principles and concepts which have made many millionaires are melting away and proving to be manifestly false. For instance, as I pointed out previously, many were under the impression that real estate was the only asset that always appreciated and now we are proving otherwise. There was also a long held belief that “all real estate is local” and that what happens in one area has absolutely nothing to do with what happens in another, this too is shaping up to be a falsehood as we see house prices fall and foreclosures increase from coast to coast for essentially the SAME reasons. The fact is that there are significant macroeconomic shifts taking shape that are driven by a number of different factors; sort of like the tentacles of an octopus. Bear in mind that this all started in the summer of 2007 when securitized mortgages started going bad. We can now look for similar things to start shaping up in securitized credit card, auto and student loans. These events will destroy a lot of wealth and create tremendous opportunities for profit at the same time. But that is the subject of a future article.

YOUR MONEY IS BEING STOLEN FROM RIGHT UNDER YOUR NOSE!

2008-02-27T09:34:00.000-05:00

We have all become accustomed to putting away our money in bank accounts and various saving vehicles for safe keeping and the opportunity to earn a little interest. But what would be your response if you were told that the $1000 you deposited at the beginning of the year, hoping to earn 4-5% in interest over a 12 month period will only pay you $950 at maturity? Not the $1050 you expected but $950! A decline of 5% on your $1000 while a 5% rate of inflation wipes out your interest and takes a chunk out of your principal! Well, believe it or not, that is exactly what is happening to your savings at this very moment. Your money is being silently siphoned off by the phenomenon called inflation! Let’s clarify one thing before I move on. At the end of the 12 month period your bank statement will show that you still have $1000 and that you did in fact receive interest payments of $50, but the problem is that when you spend your $1050 you will only receive $950 of value in return. In other words, your $1050 will buy much less than it could a year earlier. But if you think this thief only targets bank accounts, think again. Inflation is quite pervasive and it envelopes just about every aspect of our lives. For instance, you might have noticed that $25 gives you a lot less gas than it did a year or two ago, or that while you spend the same amount of money at the grocery store, you come home with less and less items each time. But by now we should all be mindful of the fact that world oil supplies are shrinking and thus pushing up the prices at the pump. Or that the demand for grains and other agricultural products has gone up significantly in recent times and has caused food price increases across the board. Both statements are true, but these factors alone do not explain why your dollar is buying less and less. The answer lies in a basic understanding of inflation and what causes it.

Inflation Revealed

So what exactly is inflation? The common thought is that inflation is merely the rapid increase in the prices of goods and services, or as the text books tell us, it is the phenomenon which occurs when there is too much money chasing too few goods. While I do not have any problems with the definitions per se, I must add that the root cause is really the ever increasing supply of money. Like just about anything else, money becomes less valuable when there is too much of it floating around and as it loses value it takes more and more of it to acquire goods and services. But why do we keep increasing the supply of money? Well, the money we use to pay for the goods and services we consume has to either come from the sale of goods and services that the country produces or from simply borrowing it. In this case the US, and just about every other country in a similar situation, has been borrowing instead of producing. A lot of the production of goods has been “outsourced” to other countries over the last 20-30 years. Ironically, it was the rising wages and production costs caused by inflation that encouraged outsourcing in the first place. But the bottom line is that when a country borrows money it has to repay that money with interest, and if the country is not producing enough to pay the interest, let alone repay the principal on the loan, then it will have to borrow more to do so. Thus the cycle continues and perpetuates itself. In fact, according to the Treasury Department, as of February 2008 the US national debt was some 9 trillion dollars. And when you consider that the debt was about 5.2 trillion in 2001 it gives you an idea of the pace at which the debt, the money supply and inflation are increasing and wiping out your wealth and purchasing power in the process. That’s as simple as I can put it without delving into the important but boring intricacies. Hope you get the picture.

Staying Ahead Of The Game

I often laugh when I hear an associate or friend of mine (or anybody else for that matter) boast about the returns they are making on a bank Commercial deposit (CD), Mutual Fund, 401K or some high yielding online bank account. I had a high yielding bank account for a few years until I became aware of the fact that I was actually losing purchasing power with my money sitting there. I emptied it and deployed my money elsewhere with the aim of keeping pace with inflation. Of course I took on additional risk, but basic finance dictates that the returns be greater than the risk taken -otherwise it won’t make any sense. By that metric, my decision made a lot of sense and now I am comfortably ahead of inflation, not by much, but it is much better than having my purchasing power wiped out. The point being made here is that your savings/investments must keep pace with or stay ahead of inflation in order to preserve your wealth and purchasing power. But now that we know what to do, how do we do it? Well it wasn’t so long ago that the rule of thumb was that you should buy real estate. Well we all see that myth being blown to shreds in this environment as homeowners are waking up to find that their property is worth less than it did the day before. Well that might be a bit of a stretch but you get the point- property prices are falling and the myth of perpetually appreciating real estate has been dismissed. Note that the National Association of Realtors (NAR) told us on Feb.25 that the national median existing-home price for all housing types was $201,100 in January, down 4.6 percent from a year ago when the median was $210,900. The way you safe guard your wealth is to buy assets, or investments linked to assets, that thrive in an inflationary climate. The very things that attack you today can save you tomorrow. You can benefit from the escalating gas prices and the skyrocketing food prices even as you are forced to contend with it on a daily basis. So the next time you see the prices at the pump it won’t be as painful since the money you, and just about everyone else, are being asked to cough up will (in a certain sense) end up in your pocket.

The "Playbook"

However let me point out that unless you are a large sophisticated investor with money to burn, you will not be able to benefit directly from these occurrences. So since we are average Janes and Joes with average incomes and lifestyles we have to utilize the next best method in order to take advantage of the situation. In this regard, I have been looking at Mutual Funds, Exchange Traded Funds (ETF) or single company stocks that have exposure to these areas and are well placed to profit from the situation. We can proceed on the premise that hard assets and commodities have been thriving and will continue to thrive in this environment.
Before I proceed into the details of these picks and conclude this article, I want to point out two things. First, I am not recommending these securities to anyone. I am not licensed to do so, I am merely telling you what I have been doing or researching. If you feel the need to invest in any such securities go see your Financial Advisor. Secondly, if we assume the government statistics to be correct, then the inflation rate is running at 4.5%. Therefore, whatever savings you put away or whatever investment you make, you have to start by discounting the value of future earnings by 4.5%. What that means is that you will have to make roughly 9% on your investment just to preserve your purchasing power. Now think about it, how many investments do you know of that return 9%+ per year? So that should be your starting point. You need to seek out investments that can keep you ahead of the game.
That is why I have been researching and investing in things that cover basic food, metals and energy. After all, these are the things that have had the greatest price increases in recent times. I have even mentioned a few of these stocks and ETFs in recent articles and I am mentioning them again because they continue to perform well.

The "Line up"

The Power-shares Deutsche Bank Agriculture Fund (DBA): This is an ETF that trades futures on soft commodities such as corn, wheat, soybeans and sugar and should go up as the prices of these commodities continue to go up. DBA is up 55.3% over the last 12 months and 26% since January.
The I-shares S&P Commodity Index fund (GSG): The index currently tracks 24 different commodities. The index is production weighted to reflect the relative significance of those commodities to the world economy. GSG is up 39.65% over the last 12 months and 8.38% since January.
Freeport Mcmoran (FCX): FCX is one of the world's largest miners of gold, silver and copper. As of December 31, 2006, it had 2,813,089 metric tons of proven and probable recoverable ore reserves. I think FCX is one of the most efficient mining operations in this sector and will continue to benefit from the growing demand for its products. This stock is up 67% over 12 months and down 1.8% year to date.
Arcelor Mittal (MT): This Company produces and markets steel and steel products worldwide and has significant presence in emerging markets.MT is up 49% over the last year and 10% year to date.
Petroleo Braziliero (PBR): PBR is a Brazilian oil company that engages in the exploration and production of oil and oil by-products. Interestingly, PBR is the only major oil company to have made a significant new field discovery in recent times. It is up 150% over 12 months, 26% year to date &9% since I last mentioned it.

Note:
We all have to actively manage our finances in this environment otherwise we will wake up one morning and realize that we are a lot poorer than we thought. I am still working on an article regarding housing as I promised last time. It should be along shortly as I am still sourcing data. Leave a comment or question if you have one.

Why Agri & Commodities Will Continue To Outperform & How to Profit From It

2008-02-22T10:55:00.000-05:00

If you are a buy and hold type investor I want to point out to you that buying and holding securities in the current market environment is not the wisest thing to do right now because of the increasing volatility in the markets. You may have noticed that it has become quite "normal" for the market to lose 300 points one week, recover 300+ points the next week only to lose 350+ points in a third week. This volatility is largely due to the fact that investors are not comfortable holding securities at this point because the prevailing thought is that there is still a lot of "unknowns" out there and that the credit situation brought on by the subprime problem is still in unfolding. And since credit is the life blood of the American consumer , and the economy as a whole, any adverse credit situation can and will be devastating to the markets. On the other hand the situation is a gold mine for traders and they have been doing well since the second quarter of 2007 when the subprime problem surfaced. However I have been finding opportunities for medium term gains in commodities, largely because there is a supply and demand imbalance which no amount of volatility can negate. Simply put, when demand outstrips supply in any asset class prices WILL go up and I have been pointing my long term oriented "clients" in this direction. Consider this statement taken from one of the newsletters that i subscribe to:
........ Global demand for Agri-Foods continues strong. Cash prices for most Agri-Foods have hit new highs in the past year. Those prices have moved so strongly that some nations are banning the export of grains. Is this the beginning of governments hoarding Agri-Foods? This supply situation is likely to only worsen as economies of China and India continue to expand. China is not yet a net importer of grains. But, in less than two years it will be one! Global competition for Agri-Food is further heightened by the move to biofuels. China is probably the only government actually discouraging ethanol production from grain. Malaysia is deeply concerned that the move to biodiesel will put palm oil in short supply. Palm oil represents about half of the world's consumption of vegetable oils. This list of shortages goes on as the world moves to a short supply situation in Agri-Food that could last a decade or more........ (Ned Schmidt, Agrifood Thoughts Newsletter)

As the incomes of citizens of emerging economies such as Brazil, Russia, India & China rise so will their caloric intake. Foodstuffs are up 22% or more, year over year, putting additional bids (demand) into grains, meats, etc. More grains (corn, wheat and soybeans) have been consumed than produced for 7 out of the last 8 years. Global grain supplies are plummeting........

In this regard I have been playing the sector via shares in grain processors, fertilizer producers and exchange traded funds that track the agri food sector. I think a combination of these or just one of the ETF's will be sufficient in the way of exposure. I have been "covering" the following:

1) The Powershares Deutsche Bank Agriculture Fund (DBA): This is an ETF that trades futures on soft commodities such as corn, wheat, soybeans and sugar and should go up as the prices of these commodities continue to go up. It is now trading @ $40.59 just shy of its 52 week high but I think it has a lot further to go.

2) Potash Corp. (POT): This is a leading Canada based fertilizer,crop nutrient and animal feed producer. It trades at around $154 and should continue to grow its earnings as it deepens its involvement in the emerging economies.

3) Bunge Ltd. (BG): Bunge processes, stores and ships agricultural products. Naturally, its costs will go up as the price of the agri commodities go up, but is well placed to pass on the costs to the companies it supplies. It now trades at $109 after recently reaching a new high.
This is an out take from yet another of the services I read on a daily basis and it is intended to give a sense of the supply and demand situation with commodities (metals & oil in particular):

In virtually every corner of the commodity, natural resource and metals world supplies are constrained, capacity to produce more is not in place, it takes years or decades to develop and demand is moving higher. As the emerging world and the BRIC's (Brazil, Russia, India, and China) build the infrastructure, roads, cars, appliances, power plants, factories and homes necessary to support their emerging middle classes, enormous amounts of raw materials will be required to do so......... Oil output is falling in Venezuela, Mexico and Iran precipitously as fields are poorly maintained, underinvested in and milked for short-term gain.......Russia is flaring more natural gas than the United States uses in a year, as it has NO ability to capture or transport it from the oil fields. Consequently, shortages are set to increase in these vital areas......... OECD oil inventories are approaching 4 year lows, global oil production is about 75 million barrels a day, usage is about 85 million barrels (bio-fuels and substitutes account for the difference) Opec's production is maxed out and bio-fuels cannot expand fast enough to meet additional demand. Bio-fuels have already caused widespread FOOD shortages, environmental destruction and exploding prices....... (Ty Andros, Tedbits)

The so called hard commodities (oil, copper, gold, aluminum, etc) can be played via the shares in miners, processors or ETFs that track the particular commodity or sector.

1) Arcelor Mittal (MT): This company produces and markets steel and steel products worldwide and has significant presence in emerging markets. It presently trades @ around $76 per share. I think it could very well be a good way to play the infrastructural development taking place in emerging economies.

2) Petro Brasiliero (PBR): PBR is a Brazilian oil company that engages in the exploration and production of oil and oil by-products. Interestingly, PBR is the only major oil company to have made a significant new field discovery in recent times

(http://www.reuters.com/article/marketsNews/idLTAN2225840820080122?rpc=44) and is well placed to take advantage of the increased demand for the commodity.

3) Oil Services Holders (OIH): OIH is an ETF that tracks the shares of companies involved in the drilling, extraction and transportation of oil on contract to big oil companies. I believe this sector will benefit as global oil companies intensify efforts to recover oil from hard to reach reserves in order to meet market demand.

4) Freeport Mcmoran (FCX): FCX is one of the world's largest miners of gold, silver and copper. As of December 31, 2006, it had 2,813,089 metric tons of proven and probable recoverable ore reserves. I think FCX is one of the most efficient mining operations in this sector and will continue to benefit from the growing demand for its products.

As i mentioned in opening, the volatility in the market is quite pronounced and you may have to take profits and get back in these commodity plays a few times on the way up. As we all know these share prices will not go up in a straight line (just look at any chart).

NOTE: Of course there are quite a few more companies and ETFs which will be beneficiaries of this ongoing global commodities bull market, but in my estimation the companies I have listed will stand to do better than most by virtue of the fact that they are better prepared and have global coverage in terms of their markets and raw material sources. You will also note that, on a dollar basis, these companies and ETFs seem a bit pricey but I would like to point to the fact that on a valuation basis they are quite attractively priced especially when you consider that demand is strong and growing and that these companies operate on a relatively low fixed cost basis.

I would also like to point out that even though all the indicators are pointing to a bull market in commodities which may last for years, the threat of an outright recession is real. Constantly rising prices in a shrinking or recessionary economy can lead to demand destruction where demand for the product falls because the market simply cannot afford it. It is not far fetched that such a scenario could play out in the not so distant future and we ought to be mindful of it. Furthermore, I am not one of those who believes that the worlds emerging economies have "decoupled" from the US economy and that a recession in the US would have very little impact on them. On the contrary I still believe thatThe US is a major market for just about all emerging economies and while they are increasingly trading among themselves i do not think these economies can keep growing at the pace they are now growing if US demand for their products slows or shrinks. Therefore if the US recession turns out to be severe and protracted it will cause a global slowdown and, by extension, a fall off in demand for commodities.

Where next? If history is enough to go by, then the first to fall in a recession will usually be the first to rise in a recovery- or at least the strongest among them-. I am therefore in the process of assembling a list of housing, housing related and financial companies that I think will be good to start accumulating. It will be ready in two weeks. These picks however will have a three to five year time frame. In the mean time ride out the recession and the jittery markets with the commodity plays.

More Downside for Moody's

2008-02-11T22:02:00.000-05:00

Moody’s, like Standard and Poor’s, has found itself at the center of what could very well be the next shoe to drop as the subprime issue continues to unfold. As things are now, Moody’s is still considering a likely downgrade of the beleaguered bond insurers and so called monolines, Ambac and MBIA and if such a downgrade were to take place it would likely set off a chain reaction of bond downgrades which would threaten the financial system as a whole. There is therefore little wonder why there is a concerted effort between the New York state insurance commissioner and eight banks to come up with a rescue package for one or both of the bond insurers. The fact is that if Moody’s does issue a downgrade their ratings criteria and methods will be questioned even more than they are being questioned now. And if they don’t downgrade even more questions will be raised. After all, from all indications and by using just about every possible valuation metric, MBIA and Ambac are virtually insolvent having guaranteed bonds valued at many times their capital base. How could a firm like Moody’s miss this?
Now lets say the team manages do bail out the bond insurers, I do not think it would be business as usual for the likes of Moody’s. The confidence once reposed in a Moody's triple A rating has been badly shaken and has started to manifest itself in the company’s stock price. In its most recent report the company reported a 54% drop in earnings and signaled a weaker 2008:
The severity and protracted nature of current credit market dislocations confirms that the challenges of 2007 will persist well into 2008," Moody's Chief Executive Raymond McDaniel said. "It is going to be a challenging year, both inside and outside the U.S."
In addition to this we are told that Moody’s, as well as other ratings agencies will probably have to deal with increased regulatory scrutiny going forward. The regulators could very well start taking a look at the relationship between these ratings agencies and the issuers they work with. This could cut deeply into profits especially in light of the fact that a significant part of Moody’s earnings comes from companies issuing bonds as the WSJ told us last Thursday:
Regulators are probing whether the three companies were too cozy with investment banks. A slew of self-imposed overhauls have been denounced by New York state's attorney general, Andrew Cuomo, as "too little, too late."
Moody’s, having been around for so long, has become engrained in the global financial system and has taken on the aura of a sacred cow, so in many investors minds it is hard to imagine the global markets without a Moody’s, just like many never thought we would see the end of Arthur Andersen. I am not suggesting that Moody’s will go broke and disappear but I believe that it will be significantly weakened in the medium term and will have to undergo an intense period of restructuring in order to continue. In the meantime the stock price is likely to head lower as bond investors and issuers go elsewhere in search of a less troubled rating agency and outside the glare of the regulators. I expect Moody’s to pull out all the stops to stem the decline in the stock price. In fact they have already started by announcing a stock buy back and new self imposed regulations as announced in the earnings conference call. But I do not think it will be enough especially since we are learning, thanks to Bill Ackman, what MBIA and Ambac had on their books, all of which is turning out to be some of the worst quality structured products, yet these firms continued to carry a triple A credit rating. http://www.yousendit.com/transfer.php?action=batch_download&batch_id=Mmd0UXVuQzMzeUxIRG Even if MBIA and Ambac had no subprime exposure, the very fact that they had liabilities that were way in excess of their capital makes one wonder why Moody’s and others continued to assign the triple A credit rating. The bottom line is that the unfolding situation has severely tarnished the Moody’s shield, the stock has fallen more than 50% year to date and from all indications it will continue to suffer as the situation persists and more of the mess is brought to light. I have been short MCO since October 2007and have covered only 40% of the position so far.

The Problem With Capital One Financial (COF)

2008-02-11T19:09:00.000-05:00

I originally posted this article at www.seekingalpha.com a month ago

On Wednesday, January 16, 2008, Fitch affirmed its previous A- ratings on Capital One Financial (COF), citing the company’s strong business and solid liquidity. The stock closed the day up 3% from its previous day's $42 close. The Fitch report presented a fairly stable picture of the company and handed a bit of hope to the bulls.
However, I want to take a look at the language in the report, and a few other facts, and show why I think this presents a rather bearish case for the company. Fitch had this to say about the company’s situation: Credit deterioration beyond current expectations with a corresponding hit to segment profitability, particularly in US Card, an absence of earnings and asset quality improvement in the auto segment, decreased liquidity, or weakening risk-adjusted capitalization could trigger negative rating actions (and earnings potential).
I would like to substitute that word “could” in the report with “will”. If we take a look at the business segments mentioned we will see that the credit card and auto loan segments are the areas in which the latest round of the subprime situation has manifested itself. There have been recently published reports of increased credit card delinquencies and auto loan defaults. And get this- Capital One is one of the leading subprime credit card issuers with a reputation of extending credit to less than suitable borrowers. As far as the part about decreased liquidity is concerned, we all know that reasonably priced financing is hard to come by with the confidence in the credit markets so seriously shaken and most lenders taking a wait and see approach or seeking capital injections to beef up their own balance sheets.
The fact is that the worsening macroeconomic conditions will only impact negatively on the business segments mentioned and you can add to that the personal, student and mortgage loan businesses which Capital one also operates. But just in case we are too far gone with the pessimism, Fitch wants us to know that all is not lost and that stabilization of segment credit metrics, improvement in the UK credit card portfolio, and a turnaround in the auto business with the development of consistent segment profitability, could provide positive rating momentum.
Interpreted to mean they are hoping that not withstanding the mess in the credit markets, the economy and an increasingly burdened consumer, improvements in the auto business will save profitability. We know better. Just last Thursday the company announced that its full year profit would come in 21% lower than forecast citing, among other things, mounting consumer loan losses. I think it only gets worse from here on. I also get the feeling that there is a lot of crisis management taking place. Evidence of this lies in the fact that the company basically had their bank, Capital One National Association, through a holding company; take over the Auto Finance portfolio on the basis that it will allow: the auto business to leverage the bank's deposit funding. This change will make COF less reliant on the capital markets, which is a positive development, given the uncertain environment.
It seems to me that they are seeing early signs of trouble in the Auto loans business and are taking preemptive steps. This could be seen as good management if it were not for the fact that the auto loan business will not be the only segment that will need propping up. Furthermore in its most recent sec filing COF stated that their balance sheet position is very strong with some 29 billion in available liquidity. But I would like to point out that this “liquidity” consists of: unencumbered and highly liquid investment securities, unused committed conduit capacity, and available borrowing capacity from the Federal Home Loan Banks.
OK. I have a few questions here. What exactly are these highly liquid investment securities? Are they of the subprime variety? How long will they remain “highly liquid” in this credit environment? Just how committed is this unused conduit capacity in this increasingly recessionary economy? And when they speak about borrowing from Federal Home Loan Banks are they referring to the Macs- meaning Fannie (FNM) and Freddie (FRE)? The same Fannie and Freddie with the ailing balance sheets? The present situation does not look so good for COF. They are trying to deal with the problems but their methods are suspect (shifting auto finance to its bank). And their contingencies are questionable at best.
I expect a little more light to be shed on the COF situation at their earnings conference call later this month when the questions start coming in. If the answers to some of these questions do not hold water (and I suspect they won’t) the downgrades will be fast and furious and the stock price will falter further. Of course, the Fed will probably dish out a 50 basis point cut at the end of the month and throw a lifeline to COF and the entire financial sector. I expect an initial positive reaction in the stock price and then, when the situation is reassessed, we should continue on our downward march. The Fed will not be able to help everybody. The reason why capital is so hard to get these days is not due to a lack of money; there is plenty of money in the system. The problem is a lack of confidence in the system - and a lot of uncertainty about what lies on the balance sheets (and in the SIVs) of financial companies like COF.