December 2007


Few days ago I’ve posted that the recession possibly started in December with a chance 70%-80%. The final argument was that the combined commercial paper plus bank credit was in decline.

Well, I should learn for the future that one week of data is not enough. In the week of Dec 19 the banking credit jumped by $71 bln to offset the $54 bln decline in CP the same week. Feds are tight but someone is hanging around the discount window with $5 bln. Please keep in mind that banking credit is more expensive than commercial paper so the credit services charges are growing to offset the rising default risks.

That means that the credit expansion had resumed and the picture is as blurry as it was before. I downgrade the recession call for December down to 60%.

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I saw people on message boards are asking: what is the TED spread?

It is a difference between 3 month treasury yield and 3 month Libor, i.e. it is a measure of panic at the financial markets. Usually it stays constant for many years in a row and newcomer investors don’t even know what it is. It is similar to those realtors that think that home prices never go down – they are just too young to know that they do.

The chart for TED spread is here:

Compare with VIX:

I think whenever the TED spread and VIX are not in sync it makes a great investment opportunity, because sooner or later stocks will follow – for an example take June-July period

Look at this S&P 500 chart:

spx triangle

I’m not a chartist, but it looks like a triangle to me, which will come to the breakout point 5-7 trading days from now.

Which way it will break-out? Well, based on fundamentals you know which 🙂 But let stick with charts.

spx 150 dma

Here I’ve made you a very nice 150 days moving average (thick blue line) shifted back by 76 days. It fits nicely with the last 2 years action and making a nice round top back in July.

So I think $SPX will break down in early/mid January and fall down. The equilibrium point in the following 2-3 months will be a zone between 1360 and 1460. The 1360 is a nice 8% drop from current level.

Myself, I do not plan to short $SPX, it’s more a benchmark than real position. For example, Russell 2k is much weaker as it doesn’t have big oil and pharma corporations that are looking attractive. When S&P 500 goes down everything goes down, especially what has to go down 🙂

I think the discussion in my last gold post was rather heated, so let me address this problem once more. Here is 104-year chart of Dow Jones vs. Gold (please click for full image, picture taken from http://www.chartsrus.com/):

dow gold 104 years

I think the conclusion is pretty simple:

  • The ratio makes wild but periodic swings, pretty well synchronized with Kondratieff wave
  • In general stocks outperform gold, but the counter-trend moves are wild and can kill you
  • Stocks also pay dividends that are not reflected on this chart, so it’s clear that on the long run gold doesn’t makes any sense as an investment, only as a swing speculation
  • If you account for dividends Gold was outperforming Dow for only 20 years during the last 107 years, i.e. time statistics is also strongly against a gold investor
  • Right now we are in the counter-trend move, when gold is doing better than stocks
  • Just looking at the chart the counter-trend moves down take from 3 years back in 1930s to 15 years 1965-1980
  • The current move is 7 years old and is at 16 (the chart ends in 2004)

Those were indisputable facts. Now will be my opinion:

  • I don’t think the current move will take 15 years, more likely 10, i.e. Dow/Gold ratio will bottom in 2010
  • I don’t think it will bottom all the way at 3 like in previous times, I would say around 6-8 is more realistic
  • I think the bulk of this move will be done by Dow decline, not gold increase
  • If Dow will bottom around 7,000-8,000 then Gold will top between $900 and $1300. In this scenario shorting Dow is much more profitable than going long Gold
  • At the extreme case, to get to the ration of 3 the Dow will need to get down to 6,000 and gold to $2000, but I consider this very, very unlikely

Disclaimer: I have no position in Dow nor in Gold, I have tons of better ways to invest my money

Very interesting twist came from the wire. Recently several western financial institutions accepted the rescue from Far Eastern sovereign wealth funds.

The biggest European and American banks have ensured their immediate survival by selling large stakes to sovereign investment funds from emerging Asia and the Middle East. The trend reverses the wave of western investment into debt-laden Asian companies a decade ago

But now there is an interesting condition that I hope the dealmakers are aware of, as described here:

There is a significant error being made by these USA financial entities. They are looking at Asian investors as having the same mindset that North American or European investors have. That is a major mistake. You might be able to trash US or European investors and personally get away with it but that is not so with the new trillionaire Asian sovereign funds or personal Asian money.

So what is most important to keep in mind?

1. Transactions made in Asia are made with the individual in charge as MUCH AND MORE than the bank holding company that signs the contract. The CEO of the international investment bank taking this money is looked at as the entity they have invested in.

2. Do not waste, lose, and most importantly steal their money. Steal means take the funds under any false basis.

So what happens if you do something wrong?

The next story has to do with my friend and neighbor Nicolas Deak. He was a personality in the currency and bullion world, owning various US, Hong Kong and Swiss banks, dealerships and other financial entities.

Nicks bank in Hong Kong went broke with rumors of a 5th column in the staff there that had enriched themselves. Nick may have been a better entrepreneur than manager.

About a year later, a lady arrived at the office of Deak & Company on Broad Street. She first went into Otto Roethenmunds office and asked where Mr. Deaks office was. Before Otto could answer she turned and walked down the hall right past Nicks PA, and into his office. She opened her pocket book and withdrew a Smith & Wesson .357 and blew Nick away.

The police investigation revealed that she was homeless, and a formerly institutionalized mental patient.

She was well dressed and had just flown in from the coast. The pistol she used was brand new

Whenever you hear something in the news just keep this interesting article in mind

I’m sure I will provoke a violent negative reaction but I will say two things about the price of gold:

  • Gold is not investment, it is a pure speculation
  • The fundamental price of gold is unchanged in the last 2000 years

I.e. if you had some ancestors who acquired some gold 2000 years ago and buried it into the ground and now you’ve finally dug it up you will get more or less the same value out of it plus-minus some short-term fluctuations. To get rid of those fluctuations, if you sell an equal fraction of this gold every 10 years at the end of the transaction you will get a 0% profit from your investments over 2000 years.

Which is ridiculous, even a dumb investment into treasury bills will kill gold over time.

So what is the fundamental price of gold?

At the end of the day 100% of the final gold consumption is jewelery. You will say that gold is actually used as money, as treasury reserves and that kind of wealth preservation. This is wrong. This is not different from putting oil into strategic reserves, this is just a temporary preservation of intermediate material for later use. It’s just the fact that this intermediate preservation is so long that it’s fooling you. But at the end of the day there is absolutely nothing else you can do from gold but jewelery.

And the fundamental price of gold is very simple: it is exactly at the level that allows a middle-class income earner to buy two golden rings when he gets married without stressing his budget too much. That was 2000 years ago and it is now.

When the price of gold gets too high against the fundamentals the final consumer is voting with his legs and here’s the proof, as reported by Big Picture:

Luxury goods, excluding jewelry, rose 7.1%. If we include jewelry, the luxury category declined 1.9%

Here we go, the fundamental price of gold is violated, the final consumer is switching from gold to other luxury items. He just doesn’t think that gold is worth the price.

The conclusion is simple: I think that if the consumers across the globe will do what U.S. consumers just did the inflation-adjusted price of gold few years from now will be lower than it is now, maybe even much lower

Very simple. This is the S&P 500 percentage of stocks above 200 days moving average:

spx200

As you can see the line is in downtrend all the way from June. The gold line is S&P 500. As you can see there is a negative divergence from July peak to October peak. While $SPX made new all-time high in October only 63% of stocks were above 200 DMA. The July peak was coincident with 74% of stocks above 200 DMA.

We are in Christmas rally (Merry Christmas!) but the line is at 46%.

The longer chart:

SPX200_2

The line was mostly above the magic 50% separator all the last 3-4 years. But now it spends all the time there. And you know that for every stock the 200DMA line is a magic crossing that is hard to penetrate both from above and below. There are no enough leaders to push the index up much more. The October high looks like a mount Everest as early as only two months later

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