Archive for November, 2010

All That Glitters

Monday, November 29th, 2010

10 Years of Gold

In my normal review of charts over the weekend (OK, so its keeps me occupied during the Bears game) I noticed how orderly the long-term performance is for gold. This 10 year chart of the gold price shows what a secular bull market should look like. I’ve drawn moving average price channels so you can see how the price has moved basically up and down 10% on either side of the 13 week moving average in a fairly steady upward direction.

The fundamentals in our economy have dictated that gold should go up as the value of the dollar has been eroded. It is easy to see the movement of the dollar over this same time frame in the chart below:

US Dollar 10 years

Its not a perfect correlation, but you can see that gold has moved up as the dollar has moved down. From an investment management standpoint, since the stated policy of the Federal Reserve is to devalue the dollar, then to counter the impact of that, you need to add gold to your portfolio.

The 24 carrot question is: what is my entry point if I don’t own any gold, or when can I safely add to what I already own?

If you look at the chart, you can see that a really safe point to initiate or to add to positions is near the bottom of the channel. That, however, is not a common event. So, when the price moves into the lower half of the channel, that has historically been a good point.

We pared back our holdings of gold and gold miners during the big rally. We will reestablish those positions when gold moves back into the lower part of the channel.

I also think that we will see an extension of the current dollar rally based upon the economic problems in Europe and its impact on the Euro. This near-term phenomenon could artificially drive down the price of bold toward the lower channel – if that happens, we will be overweighting our position.

Everything in investment management is about controlling risk – in a strange economy like our current one, raising cash on outsized rallies and putting that cash to work in selloffs is the best way to control risk and enhance returns. We’ve been employing that strategy with success so far and believe it will be the norm for the foreseeable future while the markets meander on a road to nowhere.


Is This The Peak of Mortgage Refinancing Boom?

Wednesday, November 24th, 2010

I saw this story on Reuters and it makes me wonder if we’ve seen the peak in refinancing. The increase in fees is minimal, but the increase in required down payment to 25% will keep some people on the sidelines. Look for Fannie Mae to follow suit in the near future.

Freddie Mac says to hike fees on some mortgages

Tue, Nov 23 2010

By Al Yoon

NEW YORK (Reuters) – Freddie Mac (FMCC.OB: Quote, Profile, Research, Stock Buzz), the second-largest provider of funding for U.S. home mortgages, will raise some fees on loans it finances, a sign it sees greater risks even for borrowers making regular payments.

The company, struggling to recover from the worst housing slump since the 1930s, will raise some so-called “delivery fees” in March to cover increased risks on loans covering large portions of a property’s value, according to a bulletin dated Monday on its website.

The fees are charged to lenders, but will likely raise costs on many loans for both purchases and refinancings, including those already funded by Freddie Mac.

While Freddie Mac said its increases would generally have little impact on monthly payments — perhaps less than $10 — they may further chill refinancings that have already had a tepid response to record low interest rates, analysts said. Borrowers have been unable to refinance as banks tacked on additional requirements and property values eroded

“I fail to understand the logic of this policy when the agencies already own the credit risk, and the borrowers are making payments,” said Paul Norris, head of structured bonds at Dwight Asset Management in Burlington, Vermont. “The last thing we need is more people giving up, more strategic defaults, and more delinquent loans.”

While lower rates make a loan more affordable, they don’t always reduce mortgage risk, a Freddie Mac spokesman said.


The move highlights the balance the government-chartered “agency” must make between protecting taxpayer funds as the housing market teeters, and providing the credit needed to preserve a fading recovery.

In September 2008, the U.S. government seized Freddie Mac and rival Fannie Mae and placed them in conservatorship. Since then, they’ve required more than $150 billion in capital from the U.S. Treasury to cover credit-related losses and the cost of dividends paid back to taxpayers.

Among changes, Freddie Mac will generally raise fees by 0.25 of a percentage point to 0.75 percentage point on mortgages with a combination of high loan-to-value ratios and/or lower credit scores.

However, even the most creditworthy borrowers would be affected unless they put

    25 percent down, up from the 20 percent

that has long been the minimum equity needed to escape the need for mortgage insurance.

“This makes 75 percent the new 80 percent,” said Scott Buchta, head of investment strategy at Braver Stern Securities in Chicago, of the maximum loan taken without added fees.

One of the major changes is to account for properties with second liens, the spokesman said. Home equity loans and credit lines boost combined loan-to-value ratios, which when high, have a huge negative impact on loan performance, according to Amherst Securities’ strategist Laurie Goodman.

Fannie Mae will likely follow with a similar move that will raise consumer costs, Glenn Schultz, head of structured product research at Wells Fargo Securities, said in a research note.

“We assess our pricing on an ongoing basis and make changes based on a variety of factors including the risk profile of loans sold to us and other market data,” a Fannie Mae spokeswoman said in an e-mail.


Many economists have painted a sobering view of the housing market in recent months, expecting prices to fall further after a reprieve last year. Missteps at mortgage companies working with troubled borrowers have delayed foreclosure, creating a bigger backlog of properties that are likely to pressure home values as they hit the saturated market.

Existing home sales fell more than expected in October, the National Association of Realtors said on Tuesday.

“The changes help to ensure that we are adequately compensated for the continued provision of essential liquidity to the mortgage market, and are able to continue our support for affordable lending while being diligent stewards of taxpayer funding,” Freddie Mac said in Monday’s bulletin.

Charles Haldeman, Freddie Mac’s chief executive officer, last month said the housing market would likely be still too weak in the next year for the government to cut its support. Freddie Mac and other government programs now provide 90 percent of all funding for U.S. home loans.

Freddie Mac stressed that the fees do not automatically result in a change to the amount a borrower pays, and added costs are likely to be “nominal.”

If a lender applies a 0.25 point fee to an interest rate, it would add less than $10 to the monthly payment on a 5 percent, 30-year loan of $200,000, it estimated.

First Greece, Then Ireland, Now Spain

Tuesday, November 23rd, 2010


Tyler Durden is reporting that yields on the Spanish 10-year government bond have hit all-time highs as worries about the fiscal situation in Spain intensifies. Bond investors are requiring ever higher yields to loan money to the Spanish Government.

This can have a big impact on financial markets, much like the Greece situation did to derail the market in April. Is this what the predictive ability of the bank index (see the previous post) is telling us? Hard to tell.

One thing that Tyler mentions is that if the US 10-year bond were to do this, based upon the sheer extent of US Treasury bonds bought in QE2, the impact on our Federal Reserve would be to exhaust all of its capital four times over.

The unanticipated impacts of QE2 continue to come to light.


Bank Index Leads S&P 500 Index

Tuesday, November 23rd, 2010


One of the things I always like to watch to tell me where the stock market is going is the Bank Index. The chart above compares the bank index to the S&P 500 index. Since 1994 when data became available, the Bank Index (the red line) has always led the S&P500 index (the green line) going up first and going down first.

As you can see from the chart above, the bank index is going down now. The question is, will it again show its predictive capabilities OR has QE2 altered the normal relationships between the asset classes and economic sectors?

As the Fed pumps more and more money into the system, it is finding its way into the investment world. And, given the low (and surprising to the Fed, rising) yields on bonds a lot of that money is going into large cap stocks. However, investors seem to be buying specific areas of large cap stocks and not simply the broad market – if they were, banks and the S&P would be rising in tandem, but they are not. There is an explanation for this – first the mortgage foreclosure scandal announced a few weeks ago and now the insider trading scandal that is just breaking into the news.

I have no answer for this, but in spite of the engineered impact of QE2, I think the historic relationship between the two indices is substantial enough that it should at least give investors caution.

We sold into the rally in the broad market and are sitting on cash in the money market fund waiting for a sign on which way the market is headed. There are lots of signs that show the market should be headed down (a rising dollar and a falling bank index are two big ones).


The chart above of the dollar shows that we have been trading in line with the Fibonacci retracement levels and have moved solidly through several of the moving averages. My best assessment is that we are headed for a test of 80 on the index, which represents a fairly serious overhead resistance level represented by the 89 day moving average and the 61.8% Fibonacci retracement level.

If we break through that noise, then there will be significant pressure on the S&P 500 index to retreat – and we may see that the predictive properties of the bank index remain in tact.


Municipal Bonds Crushed by QE2

Monday, November 22nd, 2010


I am in the middle of writing my year-end newsletter, and part of it discusses unintended consequences. Well, looking at this chart of the municipal bond etf index fund I think we can easily spot one unintended consequence of the Federal Reserve’s latest foray into monetary easing: a 5% drop in the value of municipal bonds.

The bond market has been moving in exactly the opposite direction from the intended results of the Fed’s actions. They intended for yields to drop giving a stimulative effect to the economy. The bond market seems to be saying something completely different – it seems to be saying that more monetary stimulus will be inflationary and is taking a preemptive swing a bond holders. Muni bond holders seem to have taken the brunt of the initial swing, but other areas will likely see similar if not bigger negative moves – I’m thinking the high yield sector is likely vulnerable although on the chart below you can see that it hasn’t been impacted as much yet.


I’ve been away from the blog for a couple of weeks (for good reasons – I was in Honduras with the Rotary Club visiting the Children’s Home we sponsor and helped construct – you can check out the photos at my other website if you have an interest in such charitable work by following this link: Photo Link – Honduras Children\'s Home Visit – and last week was my board meeting week) plus I’ve been working on the newsletter which takes countless hours to produce.

However, things should be all right now and the posts should be more regular.


Fed Policy Commentary

Friday, November 5th, 2010

The gold and the stock market shot up yesterday in reaction to the most recent announcement of easy monetary policy by the Federal Reserve, known as Quantitative Easing 2 (QE2 for short).

There seems to be general agreement on Wall Street that this is good for the economy and the financial markets, and that may be the case. However, I think there a lots of pitfalls that could make this a short-term stimulus with longer-term consequences.

Below is an article from Mike Shedlock that summarizes the various potential negative consequences much better than I could:

Friday, November 05, 2010

South Korea, Hong Kong, Brazil, China, Volcker Complain about Bernanke’s QE Policy

A parade of countries have expressed grave concerns over the Fed’s misguided Quantitative Easing policy.

South Korea Aggressively Considers Curbing Capital Inflows

On Wednesday South Korea Warns It’s Close to Curbing Capital Inflows

South Korea on Thursday issued its strongest warning in months that it was close to taking steps aimed at curbing fund inflows, saying it would “aggressively” consider taking such measures.

“The government believes it needs to turn away from the perception that controlling capital flows is always bad and consider introducing measures to improve the macroeconomic prudence,” the Ministry of Strategy and Finance said in a statement.

“The government will ‘aggressively’ consider implementing relevant measures, the ministry said after listing recent remarks made internationally in favor of capital controls.

The statement titled “a message to the markets” was issued hours after the U.S. Federal Reserve said it would buy billions more in government bonds by the middle of next year.

Brazil Central Bank Says QE Causes Distortions and Excessive Liquidity

Please consider Brazil’s Meirelles: Fed’s latest move on G20 agenda

The head of Brazil’s central bank said on Thursday that the U.S. Federal Reserve’s latest plan to lower domestic borrowing costs and jumpstart the ailing economy would cause further “distortions” in world markets and complicate his country’s efforts to stem the rise of its currency.

“QE creates excessive liquidity that flows over to countries like Brazil,” Meirelles said. “Definitely, for Brazil it does create a problem and Brazil will present proposals in that regard to several countries — the U.S. and China — to reach a different agreement not to generate so many distortions.”

Hong Kong Monetary Authority Warns of QE Related Housing Bubbles

Bloomberg reports Fed Easing Worsens Hong Kong ‘Bubble’ Risk, Chan Says

The U.S. Federal Reserve’s expansion of stimulus will add to the risk of a housing bubble in Hong Kong and may force extra measures to cool prices, said Norman Chan, the head of the city’s central bank.

The Hong Kong Monetary Authority will “take measures that are specific to the housing market if necessary,” Chan said at a press briefing in the city today. “The risk of an asset bubble in Hong Kong’s property market is rising.”

Hong Kong has already tightened purchase requirements after home prices rose about 50 percent from the start of 2009 to the highest level since 1997, according to an index compiled by Centaline Property Agency Ltd.

The Fed’s move to buy another $600 billion of Treasuries, announced yesterday, will “definitely add pressure to the asset markets in emerging-market economies,” Chan said.

China Central Bank Says “Unbridled Printing is Biggest Risk to Global Economy”

A China central bank says U.S. dollar printing is huge risk

Unbridled printing of dollars is the biggest risk to the global economy, an adviser to the Chinese central bank said in comments published on Thursday, a day after the Federal Reserve unveiled a new round of monetary easing.

China must set up a firewall via currency policy and capital controls to cushion itself from external shocks, Xia Bin said in a commentary piece in the Financial News, a Chinese-language newspaper managed by the central bank.

“As long as the world exercises no restraint in issuing global currencies such as the dollar — and this is not easy — then the occurrence of another crisis is inevitable, as quite a few wise Westerners lament,” he said.

Li Daokui, another academic adviser to the central bank, said loose money in the United States would translate into additional pressure on the Chinese yuan to appreciate. “A certain amount of capital will flow into China, either through Hong Kong or directly into the mainland,” Li said.

Fed Governor Richard Fisher Blasts QEII

On October 7, Fed Governor Richard Fisher blasted the idea of QEII in To Ease or Not to Ease? What Next for the Fed?

In my darkest moments I have begun to wonder if the monetary accommodation we have already engineered might even be working in the wrong places. Far too many of the large corporations I survey that are committing to fixed investment report that the most effective way to deploy cheap money raised in the current bond markets or in the form of loans from banks, beyond buying in stock or expanding dividends, is to invest it abroad where taxes are lower and governments are more eager to please. This would not be of concern if foreign direct investment in the U.S. were offsetting this impulse. This year, however, net direct investment in the U.S. has been running at a pace that would exceed minus $200 billion, meaning outflows of foreign direct investment are exceeding inflows by a healthy margin. We will have to watch the data as it unfolds to see if this is momentary fillip or evidence of a broader trend. But I wonder: If others cotton to the view that the Fed is eager to “open the spigots,” might this not add to the uncertainty already created by the fiscal incontinence of Congress and the regulatory and rule-making “excesses” about which businesses now complain?

In performing a cost/benefit analysis of a possible QE2, we will need to bear in mind that one cost that has already been incurred in the process of running an easy money policy has been to drive down the returns earned by savers, especially those who do not have the means or sophistication or the demographic profile to place their money at risk further out in the yield curve or who are wary of the inherent risk of stocks. A great many baby boomers or older cohorts who played by the rules, saved their money and have migrated over time, as prudent investment counselors advise, to short- to intermediate-dated, fixed-income instruments, are earning extremely low nominal and real returns on their savings. Further reductions in rates earned on savings will hardly endear the Fed to this portion of the population. Moreover, driving down bond yields might force increased pension contributions from corporations and state and local governments, decreasing the deployment of monies toward job maintenance in the public sector. Debasing those savings with even a little more inflation than what is above minimal levels acceptable to the FOMC is unlikely to endear the Fed to these citizens. And if―and here I especially stress the word if because the evidence is thus far only anecdotal and has yet to be confirmed by longer-term data―if it were to prove out that the reduction of long-term rates engendered by Fed policy had been used to unwittingly underwrite investment and job creation abroad, then the potential political costs relative to the benefit of further accommodation will have increased.

Part of our cost/benefit analysis should include where the inertia of quantitative easing might take us. Let’s go back to that eye-popping headline in yesterday’s Wall Street Journal: “Central Banks Open Spigot.”

My reaction to reading that article was that it raises the specter of competitive quantitative easing. Such a race would be something of a one-off from competitive devaluation of currencies, a beggar-thy-neighbor phenomenon that always ends in tears. It implies that central banks should carry the load for stymied fiscal authorities―or worse, give in to them―rather than stick within their traditional monetary mandates and let legislative authorities deal with the fiscal mess they have created. It infers that lurking out in the future is a slippery slope of quantitative easing reaching beyond just buying government bonds (and in our case, mortgage-backed securities). It is one thing to stabilize the commercial paper market in a systematic way. Going beyond investment-grade paper, however, opens the door to pressure on a central bank to back financial instruments benefiting specific economic sectors. This inevitably leads to irritation or lobbying for similar treatment from economic sectors not blessed by similar monetary largess.

Why QEII Will Backfire

Let’s review a snip from Three Reasons QEII Will “Backfire”; Pavlov’s Dogs and the “No Choice” Argument Yet Again

Dr. El-Erian, CEO and co-CIO of PIMCO states several reasons why QEII will backfire.

1. The Fed is going it alone, without meaningful structural reforms
2. Emerging economies burdened by capital inflows in the wake of QEII will react with currency wars, protectionism, and capital controls
3. Resultant commodity price increases will increase input costs and reduce earnings of American companies

The position of El-Erian is interesting given that PIMCO founder, managing director and co-CIO endorsed QEII as discussed in Bill Gross’ Arrogant Endorsement of Fed’s QE Policy he calls History’s Most “Brazen Ponzi Scheme”.

Unintended Consequences of QEII

Mohamed El-Erian addresses the unintended consequences of Fed policy actions and the reasons Quantitative Easing will fail in QE2 blunderbuss likely to backfire.


Intended vs. Unintended Consequences

Add a junk bond bubble to the list of consequences (unintended or otherwise).

Bernanke is clearly misguided enough and arrogant enough to purposely blow a junk bond bubble as an “intended consequence”, even though the housing bubble bust proves without a doubt the asininity of such policies.

Thus, it’s hard to say if Bernanke wants a junk bond bubble or is merely willing to live with one.

Then again, Bernanke is dense enough to not have any clues about what is happening. He did not see the housing bubble, the recession, the huge rise in unemployment, and any number of other things that happened. In fact, he even denied there was a housing bubble.

In the academic wonderland in which Bernanke lives, it is perfectly possible he is oblivious to the bubbles he is creating.

However, looking at things from every angle, given that Bernanke Admits Targeting Stock Prices, I am leaning towards the first option: Bernanke is misguided enough and arrogant enough to purposely blow more asset bubbles as an “intended consequence”, hoping he can deal with them later.

Bernanke Out of Control

Points number 2 and 3 are already in play.

2. Emerging economies burdened by capital inflows in the wake of QEII will react with currency wars, protectionism, and capital controls

3. Resultant commodity price increases will increase input costs and reduce earnings of American companies

Paul Volcker on QE

Please consider Volcker: future inflation risk limits QE effect

Former U.S. Federal Reserve Chairman Paul Volcker on Friday repeated his scepticism about the benefits of the Fed’s latest quantitative easing, citing concern about long-term inflation.

He told reporters after a lecture in Seoul that short-term U.S. interest rates had almost no room to go down further, while long-term bond prices were under pressure from increasing concern about future inflation.


There is no way QEII can possibly do any good, and at least two current Fed governors know it. So does former Fed chairman Paul Volcker.

Bernanke claims to be a student of the Great Depression. The reality is he is an academic wonk with no real world experience in anything. He has proven three things however:

1. He will not listen and cannot be taught
2. He has no common sense whatsoever
3. He is dedicated to bubble blowing in response to crises

Other than that, Bernanke is perfectly suited for the job. On second thought, those traits are why he was appointed in the first place.