2009

February 5, 2009 · Posted in Weekly Posts · Comment

There is much to talk about in the markets tonight and some key events coming up in the next few days so lets get to it.

US Bonds:

Treasury yields moved up yesterday as the Treasury announced that next week they would auction $67 billion in bonds and notes and that they were reinstating the 7 year bond. This caused our PST position to move up more than the TBT position. The PST is a leveraged short of the 7-10 year treasury bond index whereas the TBT is a leveraged short of the longer duration bonds. The move in PST looks to us as primarily a supply and demand issue. The more supply coming to market the higher the rate will be needed to induce investors to buy.

Today saw yields come back a little bit. This is likely a pause, and a healthy one from our perspective, prior to two key events. The first is the employment numbers tomorrow. The employment numbers cause two opposing effects in the market at the moment. If the numbers are worse than expected then it indicates economic activity is not picking up and would typically cause rates to come down somewhat. In the current environment however it also makes the potential deficit worse and increases the need for additional treasury funding for stimulus packages and the like implying higher rates. If the number is better than expected then an uptick in economic activity could be postulated which would help rates move higher. (It is unlikely anyone would imagine our deficits dropping though). It is not possible to accurately forecast which influence will weigh out so consequently the market paused and consolidated today ahead of the news. Looking forward to next week we will get another glimpse of how receptive the market will be to the huge influx of treasuries this year. We may very well see rates moving up. From a trading standpoint we are more comfortable with a cautious market that gradually moves higher than one that takes off.

The big question overhanging the bond market is “what about the Fed?”. The Fed wants interest rates kept low as does the Treasury department. There are a couple of reasons for this. First, lower rates help keep mortgage rates low as well as other loan rates as these are often tied to Treasury bond rates. The Treasury clearly wants rates kept low in order to finance the planned deficits that are coming while minimizing the impact to the US Government’s structural deficit. Mortgage rates have been moving up along with treasury bonds. The Fed has stated that they will intervene in the markets and buy treasuries to drive the price down if required. However, there is a limit to the degree to which the Fed can enforce interest rates and the Fed knows this. The worse thing that could happen, from the Fed’s perspective, would be to have the Fed buy treasuries and find itself unable to drive the yield down much. That would be a signal to the market that the market has the upper hand. Such an event would likely impact global confidence in our market and our dollar. Readers are encouraged to also look at the Members Only Post “The Coming Bond Debacle”as well as “Fundamental Trends” and “How a Reserve Currency Collapses”.

In summary then we see the last few days as positive for our short bond positions - both are profitable. The market looks like it will continue to move to higher yields over time.

Yesterday we posted the following articles yesterday from Bloomberg. If you haven’t had a chance to look at them we encourage you to do so.

Treasuries Drop as Auction Draws Higher Yields

Start of US Depression that Will Increase Gold Price

Treasury Yield Curve May Steepen

Treasury Real Yield at 16 Month High on Inflation Bet

Precious Metals:

Precious metals made good gains today. Gold looks like it tested the $900 level and survived the test. We expect precious metals to continue to move higher though the movement will be volatile from time to time. John Reade of UBS is quoted today as raising his forecast for the average price of gold this year to $1000 dollars an ounce from his previous estimate of $700. This is meaningless as are most forecasts like this. Our macro view of bonds, the dollar, and precious metals is that we will see titanic movements in all three market over time but they will be volatile. Our objective is to understand the critical forces at work in a given period and ride them. As conditions change we will change our positions. We remain long precious metals (our positions are listed at the bottom of this post). We expect to be establishing a physical gold position shortly. We have more to say about the precious metal’s market in the Members Only Post “Gold - Reluctantly”.

Currencies:

As readers know we have been short the US dollar for some time through UDN and long the Australian dollar. Both of these positions have been underwater as the US dollar showed continuing strength and the Australian dollar showed continuing weakness. We analyzed the US dollar strength in our recent Members Only Post “Why is the Dollar Going Up (and When Will it Stop)” and concluded that our analysis was still valid. Since that time the Australian dollar has rallied strongly based on a rate cut by the Australian Central bank and a stimulus package announced by the Australian government. While our Australian position is still in a loss it is a lot better than it had been. We still believe that commodity currencies like Australia’s will do well and so we are holding our FXA position.

The US dollar has come down somewhat in the last few days as well. In our post on the dollar we analyzed a number of factors that were likely supporting the dollar - all of which are transient in nature. Jim Rogers speaking on Bloomberg today identified short sellers exiting their contracts as the driving force. Like us he ridiculed the “flight to quality” argument. In his view, the short sellers are eroding because the position has gone against them and frankly, it is taking a long time for a downward movement in the dollar to start. That is likely a factor and it is transient.

What we are seeing recently is multiple central banks intervening in the currency markets in an attempt to stabilize their currencies. They do this by selling their reserve currencies and buying their own currency. This puts selling pressure on the US dollar. At the moment the central banks of Russia, Kazakhstan, and Hungary all are intervening to attempt to stabilize their currencies. While there will almost certainly be capital flight out of those currencies into others, it is presumptuous to assume it is all into the US dollar. In fact the Swiss are fighting the increase in their currency caused by money flowing out of the ruble.

We continue to believe that the dollar is headed downwards and will be driven down by an increasing loss of confidence in the dollar due to the massive deficit spending that our government has embarked upon backed up by the printing presses of the Fed. Expect significant turmoil in the currency markets in the coming months.

Base Metals:

We hold, no positions in base metals as readers know but we will comment on them here as there has been an uptick in news in the last 48 hours. Specifically the Baltic Dry index has seen it’s biggest 1 day jump in price in over 25 years. the Baltic Dry index is a measure of the daily rate that transport vessels can be hired for. The indexes all time high occurred last year when it hit 11793. It then plummeted to 663 n a matter of months. The index has now risen back to 1316 points. Why this matters is that now almost all of the worlds Capesize ships, those are the large bulk carriers that move ore between Brazil or Australia and China, were idled through much of the latter half of 2008 as demand collapsed. Those ships are now working again. This is providing fuel for some pundits to predict we have seen the bottom of the economic crisis, a rebound is on the way. Well, no. What we are seeing is a a little more complicated. The Chinese had stated last year that they planned to keep their mills operating during the economic downturn to provide employment, to feed their domestic infrastructure projects including their stimulus plans, and to build up a stock pile of basic materials at rock bottom prices. Indeed, Murdock Global Insight discussed this in our 2009 forecast. The Chinese are doing exactly what they said they would do. That is what is driving the Baltic Dry rate. To look at it from another angle, China is one of Australia’s largest customers for metals. Australia is closing mines notably the massive Ravensthorpe nickle mine in Western Australia. It is difficult to imagine that the Australian mining companies are so out of touch with their major customer that they are closing mines as that customer embarks on a buying spree. Further, at the same time the Baltic Dry is having a great one day run, the Financial Times is reporting other cargo ships increasingly being used as floating storage containers due to lack of transport work.

In the crisis the world finds itself in there are innumerable commentators who will take any piece of information and cast it as evidence of a turnaround. The Baltic dry is an example, rising commodity prices are another (is it due to increased demand or reduced supply?). Do not fall for these comparisons. To identify a turnaround in the world’s fortunes we need to see a trend in multiple complementary indicators and dig into the data behind them.

Coming Up:

We will publish our standard Weekly Market Update this Weekend (Sunday). Depending on what transpires Friday in the markets there may be a post tomorrow night. We are also working on two Member’s Only posts. The first is a scenario view of how the Fed entering the bond market could play out. this will be similar in style to “How a Reserve Currency Collapses” (which is our most popular post). The second is a deeper look at China as increasingly it is becoming clear that China will be central to global recovery.

To view previous Members Only posts simply follow the instructions under the “Become a Member” tab and select the “One Month Free Membership” when you get to the Products page. You must complete the checkout process in order for the Membership to complete. Registration is not sufficient. You are under no obligation to continue beyond the One Month Free Trial and your e-mail and address will not be shared with third parties.

We hold the following positions as of 02/05/2009.
Short Treasury Bonds through PST and TBT*
Long gold and silver bullion through CEF
Long gold mining stocks through TGLDX
Long Agricultural commodities through RJA
Short US dollar through UDN**
Long Australian dollar through FXA**
401k remains 100% in cash

*ProShares leveraged short ETF. Investors need to understand thoroughly the risks associated with these leveraged products in light of their personal investment needs and risk tolerance. They may not be suitable for all investors.

** Position is currently in loss but we are sticking with it as we believe the fundamentals will drive the dollar substantially lower.