The Debts of a Nation

Occupy Wall Street - Marine vs 30 Cops

2011-10-18T23:05:00.004-04:00

Speaking of the police. Here is a link to a video of a soldier - in uniform - protesting the treatment of demonstrators by the police.

http://perezhilton.com/2011-10-18-marine-vs-30-cops-occupy-wall-street

Wall St Protest Photos Part 3

2011-10-18T23:00:00.002-04:00

More photos. None of the police. Let's just say they became a little . . . sensitive when I tried to take photos of their position.

Occupy Wall Street Photos Part 2

2011-10-18T22:52:00.003-04:00

Occupy Wall Street Photos

2011-10-18T22:42:00.001-04:00

Its been a while since the last post. I am going to write a series of posts about the "Occupy Wall Street Movement" later. For now, here are some recent photographs I took.

How America's Baby Boomers are Hoarding Wealth and Jobs from the Young and Minority Groups

2011-09-06T11:57:00.002-04:00

That is, of course, if recent trends hold up. As mentioned, more older Americans -- those 55 or older -- are working relative to previous generations. Fearful of not being able to make ends meet in their golden years, they're not letting go of their jobs.

By holding on, of course, they're not passing the baton to younger Americans. So you can see the cycle. Older people keep working. More younger Americans are unemployed. The wealth is hoarded by the old folks. The wealth diminishes in value without anyone (younger Americans) to whom it can be sold.

http://finance.yahoo.com/banking-budgeting/article/113447/young-jobless-will-ruin-your-portfolio

Goldbugs? Are they Right?

2011-08-12T22:01:00.001-04:00

The article is self explanatory. I will be publishing a short history of the 40th anniversary since Nixon ended the gold standard later this weekend.

http://www.reuters.com/article/2011/08/11/us-gold-bugs-idUSTRE77A3CT20110811

US States Suffer From US Downgrade

2011-08-11T13:33:00.003-04:00

After S&P's downgrade of America from AAA to AA+ it is only natural for the everyday person to wonder what practical effects will occur. It is easy to get wrapped up in the arcane intracies of high finance but a return to less nuanced and general coverage is always good.

Here is a good article that reviews what effects may occur in US states. Specifically,

States with high numbers of federal workers or contractors, large military presences or generous Medicaid programs for the needy are among the most vulnerable from Standard & Poor's recent downgrade of U.S. government debt.

The fears are that if the federal government could be downgraded then the states are not too far off. A downgrade for states would be disastrous for many as the immediate fallout would be higher borrowing costs. The review of states is also prescient as S&P's competitors, namely Moodys, are still angling for a way to distinguish themselves in the government debt markets but without the controversy followed by S&P after their federal credit rating.

Source: http://www.benefitspro.com/2011/08/09/states-await-downgrade-fallout

The bottom line: States are nervously awaiting the fallout from S&P's federal downgrade. Lower budgets to meet stricter accounting measures could result in more laid off workers, fewer contracts for local businesses,lower tax revenues, and an increased number of people on the public rolls.

Credit Spreads and Risk Assessment

2011-08-11T13:18:00.005-04:00

Ok. After a lengthy time away from posting I'm back.

Today's topic is credit spreads and risk assessment. The past 2 weeks' market roil has induced a fair amount of panic among many observers and not a few participants. Interbank spreads have widened significantly as can be expected in an environment that we are currently facing. In particular the catalyst for these fears are EU based concerns that French, Italian, and Spanish banks are not as stable as first perceived. E.g. the risk of contagion from Greece and Ireland has widened to envelop the core EU members previously thought of as the most stable.

But compare the levels of fear between 2008-2009 and the summer of 2011. I have included 2 charts above for your review. As you can see the elevated fears of risk today are nothing like that experienced 2-3 years ago.

The TED spread is not as relevant today as it was 2 years ago b/c of the persistent levels of government intervention. But it is still natural to expect interbank risk to rise and short term T-bills (the benchmark) to fall. TED has been stuck in a range bound carry trade level in order for the banks and other financial institutions to re-capitalize their balance sheets. For the common shareholders, they have lost some if not all of their funds (depending on their basis - just witness the government's effort to re-capitalize AIG, Citibank, Bank of America, etc). But for preferred shareholders the losses still bite but are offset to some degree by dividend payments.

Corporate spreads aren't that bad. Housing and mortgage rates have become dislocated from benchmarks. But corporate credit couldn't be better. Low treasury rates mean a rush by large caps to refinance at even lower rates than they were getting before.

What most people forget is the bad economic data out of the U.S. masks how well large-cap U.S. companies are doing. Second-quarter earnings have been outstanding so far, largely because the global U.S. companies are doing very well outside of their sluggish domestic market. In fact, for those w/the money this is a prime time to buy solid blue chip preferred stocks and just hold on through the market turmoil.

The bottom line: There is some panic in the markets - justifiably so in many cases. But the levels of fear being experienced today are nothing like 2008-2009 (at least so far).

The Continuation of Quantitative Easing

2011-06-27T12:05:00.002-04:00

There is quantitative easing and then there is quantitative easing. Confused? So are some market observers.

After Ben Bernanke's speech last week regarding the end of Quantitative Easing 2.0, the FOMC Committee inserted a small caveat that it will continue to buy Treasuries with proceeds from the maturing debt it currently owns. The policy is necessary to keep interest rates artificially low. The irony here is that the yields on Treasurys remains very low even without Federal Reserve intervention b/c of widespread, lingering fears about debt bubbles in Europe, political uncertainty in the Middle East, and tightening in China.

http://finance.yahoo.com/news/Fed-May-Buy-300-Billion-in-bloomberg-1457319130.html

The Bottom Line: The Federal Reserve will continue buying Treasuries after the end of QE 2.0 until it decides not to anymore.

Chinese Government Claims It Isn't Speculating on African Farmland

2011-06-24T10:48:00.002-04:00

Chinese investment in sub-Saharan Africa has been on a climb for the past few years. The lack of arable land in China is forcing the Chinese government to invest in alternate means of food security. Other investment locales include the Philippines, Cuba, and South America.

China Envoy: Govt Doesn't Advocate Companies Buying Africa Farmland
A top China envoy to Africa said the government doesn't advocate Chinese companies' acquisition of farmland in Africa and hasn't encouraged Chinese farmers to move to the continent.

While China has sought to strengthen ties with Africa in part to feed its need for resources, the comments by Liu Guijin, China's special envoy for African affairs, at a briefing to reporters on China-Africa relations, distance government policy from what the ambassador called a "sensitive" issue of an apparent rising presence of Chinese agricultural interests in developing foreign farmland for domestic food security purposes.

On whether Beijing was behind the migration of Chinese farmers from Hebei province to Africa, Liu acknowledged that some Chinese farmers had moved to some African nations in private capacity, but said the government wasn't helping them.

"The government knows that grabbing farmland is a very sensitive issue...and will not encourage it," he said.

Media reports have suggested that thousands of Hebei farmers have moved to more than a dozen African countries in recent years, setting up farming businesses in places such as Nigeria, Zambia, Sudan and Kenya.

Liu said some private Chinese companies may have their own projects in placing local personnel in Africa to develop agriculture, but Beijing's policy is aimed at sharing agricultural technology with Africa.

China is home to a fifth of the world's population but has only about 7% of global arable land, making food security a top government priority.

Chinese companies have made strides in similar ventures in Latin America and Southeast Asia.

Earlier this month, one of China's largest farming companies, Heilongjiang Beidahuang Nongken Group, signed a joint venture with Argentina's Cresud SA to buy land and farm soybeans.

Cresud is one of Argentina's top farming companies, controlling more than 1 million hectares of farmland.

Heilongjiang Beidahuang's chairman, Sui Fengfu, told Dow Jones Newswires in March that the company planned to buy 200,000 hectares of overseas farmland this year, and that Latin America was a key target.

The company is already farming 2 million hectares outside China.

Heilongjiang Beidahuang is also spending $1.5 billion to lease and develop farms on 300,000 hectares in Argentina's Rio Negro Province.

The company plans to grow wheat, corn, soybeans, fruits, vegetables and wine grapes for export to China over 5-10 years.

However, the Latin American deals are not land acquisition projects and appear to be crafted to avoid a backlash against foreign ownership of farmland in Argentina.

Argentina's President Cristina Fernandez has introduced legislation limiting land purchases by foreign individuals and companies to 1,000 hectares in rural areas.

Chinese companies are also playing an increasingly important role in developing farmland in the Philippines and Cuba, among other countries.

Source: CME News for Tomorrow

The Bottom Line: China's leaders are growing increasingly concerned about food security for its vast population. Foreign ventures in Africa, Latin America, and Southeast Asia have grown to the extent that they are provoking domestic backlash among native constituents.

India Will Join China as a Net Corn Importer

2011-06-22T16:32:00.004-04:00

India is now following China as a net grain importer. For pundits who question the underlying US trade deficit, agricultural exports continue to compose a core component of international trade.

Corn and corn derived products are used in the manufacture of animal feed products. As populations grow richer in emerging market nations they also develop an appetite for more complex proteins - e.g. meat.

India To Be Net Corn Importer By 2014-15 -US Grain Council CEO
India will join China to become a net corn importer by 2014-15, placing increased pressure on world corn markets, the head of the U.S. Grains Council said.

Speaking at an agriculture investment summit here, Thomas Dorr forecast that India will import as much as 300,000 metric tons of corn in 2014-15, rising to 808,000 tons in 2018-19. In 2009-10 India exported 995,000 tons of corn.

"We believe that in four short years India will turn into a consistent importer," he said.

This shift is expected to come as Chinese demand for corn rockets. Dorr said that despite a push by Beijing to improve domestic production, the Asian giant will increasingly rely on imports to meet rising consumption by its rapidly-expanding livestock industry.

"China's government is now coming to grips with the fact that food security and food self-sufficiency aren't necessarily the same thing," he said.

World corn production is expected to set a new record in the coming 2011-12 season and yet rising demand from emerging countries and ethanol blenders mean global corn ending stocks are expected to fall by 3 million tons, to near-historic lows.

This pressure is only expected to increase in the future. According to the World Bank, developing country populations with incomes of more than $16,000 a year are expected to rise to 2.1 billion by 2030 from 352 million in 2000, driving demand for meat.

Dorr, who is also former under secretary for rural development of the U.S. Department of Agriculture, said producers and investors have a huge opportunity to benefit from such demand growth, but it will require openness to technology, trade and investment.

The use of genetically-modified crops, which is already widespread in the U.S. corn industry but extremely restricted in other parts of the world like the European Union, will also become increasingly important in order to meet growing demand, he said.

"Non-scientific objections [to GM] must be weighed against the moral imperative to feed a world of 9 billion people by 2050," he said.

Source: CME News for Tomorrow

The Bottom Line: Both India and China will continue to experience food volatility as their immense populations grow. A government focus (rightly so) on social order and stability will have the retarding effect of hampering domestic growth in discretionary consumer spending.

McKinsey Health Insurance Report Attracts Controversy

2011-06-22T14:54:00.005-04:00

American politicians are finally getting the courage to tackle entitlement spending. For months Congress has been the scene of political theater on par w/the Greek tragedy playing out in Europe.

The latest installment in the political saga comes courtesy of McKinsey, the giant consulting firm that recently published a report that under ObamaCare, 1/3 of all US employers would drop health care coverage. The findings have resulted in a media frenzy by the insurance industry and Congress. Questions over the methodology, sample size, and types of questions are being raised.

Source: http://www.benefitspro.com/2011/06/20/mckinsey-who

The bottom line: Entitlement spending is a vaunted pillar of political spending. But it is coming under increasing attack by budget hawks. A recent survey by McKinsey has thrown more fuel to the fire. For now, there are more questions than answers.

Chinese Food Prices Rise on Flooding

2011-06-20T17:33:00.003-04:00

Floods Drive Up Food Prices In China

Flooding across eastern, southern and southwestern China has killed at least 175 people and is causing significant damage to vegetable crops, helping to drive up food prices at a time when the government is already fighting to contain inflation.

The flooding, triggered by heavy rains that started early this month, has caused widespread suffering in more than a dozen provinces and regions, with state media calling it the worst in decades in some areas.

In addition to the 175 known deaths, 86 people are missing and some 1.6 million people have been displaced by the flooding, which has caused more than $5 billion in damage, the Ministry of Civil Affairs said. Official forecasts have predicted further rain in a number of the most-battered provinces.

China goes through regular cycles of drought and flooding, and both have been relatively severe over the past year. The recent drought was called the worst in 50 years in some parts of China, and continues to affect almost five million hectares of farmland nationwide -- including in different areas of some of the same provinces now afflicted by floods.

The flood-related effect on prices for now may be fairly local, but the rising cost of vegetables has already been a leading factor in pushing inflation to near-three-year highs. Food prices in May were up 11.7% from a year earlier, compared with a 5.5% increase in the overall consumer-price index.

The flooding has reduced vegetable output by about 20% from levels a year earlier in the worst-hit places, particularly in the eastern province of Zhejiang, according to state media.

Xinhua news agency cited Jin Changlin, a Zhejiang agricultural official, as saying that vegetable prices are likely to continue to increase or remain high for about two weeks.

More than 432,000 hectares of crops have been destroyed in flood-affected provinces around the country, including 241,600 hectares in Zhejiang -- about an eighth of the province's total.

At one big market in Hangzhou, Zhejiang's capital, prices of fruits, vegetables and grains have risen about 40% on average, according to Xinhua. It didn't provide its basis of comparison. Higher food prices were also reported in Anhui and Jiangxi provinces, although the sizes of the increases were unclear.

In last year's fourth quarter, vegetables and other agricultural products including cotton, wheat and edible oils fueled a sharp surge in inflation, with prices of common produce like garlic and ginger doubling from a year earlier.

Source: CME News for Tomorrow

The Bottom Line: While summer is typically a cyclical low for agricultural futures unforseen events such as calamitous weather can have a disproportionate impact on prices. Global warming is contributing to unpredictable and savage weather as humanity continues to ignore the long term effects of the environment in favor of short term gains.

Taking a Closer Look at Brazilian Growth

2011-06-20T17:31:00.002-04:00

Here is another article about Brazil:

"The level of loans overdue by 90 days has risen rapidly in recent months to 6.1 per cent and is expected to reach 8 per cent by the end of December, said Ricardo Loureiro, president of Experian Latin America, the credit rating agency"

http://www.ft.com/intl/cms/s/0/c0b3beb8-9a9c-11e0-bab2-00144feab49a.html

Here is the problem I see w/Brazil and many other natural resource exporters. The government is relying on exports (raw materials and agriculture) and credit to grow GDP. But they are neglecting the domestic manufacturing and consumption sectors.

While exports are an old story, credit growth is something new - and it's giving an artificial boost to spending power and making people feel richer - but as many Americans learned this is an illusion. The growth projections are very impressive given the nature of leverage (which is what we are all here to discuss anyway).

But meanwhile the stronger real is making it very hard for Brazilian factories to compete w/foreign imports. We cannot speak about Brazil w/o mentioning China. (America used to be important to Brazil but has lost its place).

It is ironic that Brazil is exporting its resources to China only to have them return in the form of finished goods. Everything from clothes, electronics, tools, and household goods are cheaper to buy than Brazilian produced items. I would not be surprised if Brazilian factories are having financial difficulties. This situation will eventually contribute to what we have in America - cheap imports at the price of lost jobs and bankrupt manufacturers.

The Bottom Line:
For now investors continue to pour money into Brazil b/c there are few alternatives. Growth - both natural resource & credit based - will continue to power the country through the foreseeable future.

Chinese Investment in Argentina Continues to Grow

2011-06-17T16:57:00.002-04:00

Chinese investment in Argentina continues unabated. In response to a populist backlash among legislators, Chinese firms are entering joint ventures and other co-operative partnership deals with Argentinian companies.

China Adds Argentina's Farmlands To Its Commodities Shopping List
Chinese investment is flooding into Argentina as the Asian giant expands its global commodity hunt from the raw materials used in industry to the foodstuffs needed to feed its 1.3 billion citizens.

China's investment in Latin America hit $15.6 billion during the 12-month period through the end of May, nearly three times greater than the year-ago period, consulting firm Deloitte said in a report. Of that amount, Brazil received about 60% and Argentina close to 40%.

During the last three years, more than 70% of China's investment in the region went to energy and minerals, but farming is attracting more attention as the country seeks to fill its bowls from foreign fields.

China already buys the bulk of Argentina's soybean exports, its top crop and largest source of export revenue. Soybeans are mainly used as livestock feed in China, where meat consumption is rising along with personal incomes. At the same time, urbanization is shrinking the amount of arable land available in China.

Last week, China's largest farming company, Heilongjiang Beidahuang Nongken Group, inked a joint venture with Argentina's Cresud SA to buy land and farm soybeans.

Cresud is one of Argentina's top agriculture firms with control over more than 1 million hectares (2.47 million acres) of farmland that produce grain, cattle and milk.

Heilongjiang Beidahuang's chairman, Sui Fengfu, told Dow Jones Newswires in March that the company plans to buy 200,000 hectares of overseas farmland this year, and that Latin America is a key target. The company is already farming 2 million hectares of land outside China.

Heilongjiang Beidahuang is also spending $1.5 billion to lease and develop farms on 300,000 hectares in Argentina's Rio Negro Province. Over a five- to 10-year period, the company plans to grow wheat, corn, soybeans, fruits, vegetables and wine grapes for export to China.

The Cresud and Rio Negro deals appear aimed at avoiding a backlash against foreign ownership of farmland in Argentina. President Cristina Fernandez has introduced legislation limiting land purchases by foreign individuals and companies to 1,000 hectares in rural areas.

Heilongjiang Beidahuang's incursion in agriculture comes hot on the heels of heavy Chinese investment in Argentina's oil sector.

In February, Occidental Petroleum Corp. sold its local assets to China Petroleum & Chemical Corp. for $2.5 billion. Last year, China's Cnooc Ltd., in partnership with Argentina's Bridas Corp., agreed to buy a 60% stake in Pan American Energy from BP PLC for $7.1 billion.

China's hunger for raw materials has also led it into mining, with MCC Minera Sierra Grande SA, a unit of state-run China Metallurgical Group, buying the Sierra Grande iron mine in Rio Negro Province in 2006. The mine, which had been shuttered since 1991, made its first shipment of iron-ore concentrate to China in February.

Deloitte predicts that Chinese investment will continue pouring into Latin America, but expects a diversification in the future into other industries such as manufacturing, infrastructure and finance.

Though its growing exponentially, China's investment still makes up a relatively small share of total foreign direct investment flows to the region.

Foreign direct investment in Latin America grew 40% on the year to $113 billion in 2010, and is expected to rise 15% to 20% this year, according to the U.N.'s Economic Commission for Latin America and the Caribbean.

Source: CME News for Tomorrow

The Bottom Line: Chinese investment in Argentinian agriculture remains high but has been adjusted in recent months to account for greater co-operation with domestic firms in order to counter allegations of foreign land grabbing.

Warning Signs Flash in Indian and Brazilian Government Bonds

2011-06-17T09:02:00.003-04:00

Months of consistently raising interest rates have pushed the Brazilian and Indian government bond markets into an inverted yield curve. In an inverted yield curve, interest rates on short term government issues move higher than longer term rates and is considered a warning sign of trouble. The most stark example of this can be seen in Greece where yields on the 2 year government bond are now hovering around the 30% mark.

There are differences however. Brazilian and Indian financial authorities have been engaged in an extremely aggressive battle against inflation. Unlike the USA and continental Europe, food and fuel make up a large percentage of the core inflation component. But there is a cost to such policy. Satisfying the legions of poor and hungry comes at the price of reducing discretionary consumer spending and domestic business spending.

Source: http://www.ft.com/cms/s/0/04511554-96a0-11e0-baca-00144feab49a.html#axzz1PXQD2WwO

The Bottom Line: Aggressive action by Indian and Brazilian authorities to battle inflation have resulted in an inverse yield curve in their bond markets. This may be a warning sign of capital market implosion or more benignly (and likely), that growth may be slowing.

CFTC Delays Dodd Frank Derivatives Ruling

2011-06-17T08:56:00.005-04:00

Certain parts of the USA's Dodd Frank law on derivatives and accounting compliance measures for banks were supposed to take place automatically on July 16, 2011. No more.

The CFTC, the regulatory body responsible for trading in US futures and options, has postponed a final ruling until the end of this year (December 31st, 2011). Score another victory for the banks. Banking and financial industry lobbyists had insisted that the definitions of "swaps" and "swap dealers" remained too vague. Particularly, regulators have not even defined which non-bank - insurance companies, broker dealers, and hedge funds are considered systemically risky.

Source: http://online.wsj.com/article/SB10001424052702303848104576385372663523158.html

The Bottom Line: Legal rulemaking by US agencies has always taken a long time given the nature of lobbying. Squeezing the equivalent of several years of regulation into a short time period resulted in an extension for more time.

Modern Indian Growth: In Spite of Government - Not Because of Government

2011-06-10T00:08:00.002-04:00

Great article from The New York Times. I am not going to quote parts of the article. Instead read it directly:

http://www.nytimes.com/2011/06/09/world/asia/09gurgaon.html

The bottom line: India is growing quickly but in a very sporadic fashion. The pattern resemble islands of growth instead of a steady advance b/c of the notorious Indian government red tape.

Hedge Fund Investments in African Land are Leading to Food Price Volatility - Or Are They?

2011-06-08T20:23:00.003-04:00

According to a private think tank, hedge fund involvement in African agriculture is leading to higher food price volatility.

I can understand their line of reasoning. The legal system and what regulatory agencies exist in Africa are notoriously opaque about investment processes to begin with. Many deals have traditionally been bilaterally struck between foreign investors and high ranking government officials on an individual basis. There is a marked danger of a "land grab" by foreign investors accumulating the choicest pieces of the pie.

However, the article goes too far in blaming hedge funds for increasing food risks. Investment in agriculture requires a long term time frame with many plant growing seasons measured in years - if not decades - for crops to become fully mature. There are heavy sunk costs associated w/developing physical infrastructure and transportation networks that require an equally long time horizon. All of this economic activity is largely beneficial for native populations - particularly in employment but also the development of technical expertise.

Then there is also the possibility of nationalization - an African nation can simply renege on the terms of a deal w/foreigners and seize the farms outright. It has happened before w/other industries - namely cocao, rubber, and cattle farms.

There is also another participant in the African land investment arena that is not mentioned in the article - foreign sovereigns. Foreign governments, particularly cash rich but land poor Middle Eastern nations, have been investing heavily in East Africa for almost a decade in an effort to diversify their food stocks. Given the sparse amount of arable land in the desert and a booming demographic it is no surprise that nations such as Saudi Arabia, Kuwait, and the Gulf States have chosen to invest heavily in sub-Saharan Africa.

Talking Points Hedge Fund Africa Land Investments Increasing Food Risks -Think Tank
Increased foreign investment into agriculture land in Africa could lead to greater food price volatility and food insecurity, think tank Oakland Institute said.

The California-based group estimates that in 2009 roughly 60 million hectares of land across the continent were either leased to, or purchased by, foreign entities, many of them asset managers or other speculative-type investment houses.

Oakland Institute executive director Anuradha Mittal said many of the deals are not very transparent, are causing displacement, and mean governments are giving up control of their land.

"It's like the food land bubble," Mittal said. "In the short-run people are displaced. The long-term impact is that resources are being controlled by outside investors because these are long leases."

The think tank focused on cases in Ethiopia, Mali, Sierra Leone, Mozambique, Tanzania and South Sudan.

There has been a lot of research into so-called land grabs in Africa, where the price of land is cheaper compared with the U.S., Europe and South America.

At the beginning of the year the World Bank published a report on the rise in agriculture land purchasing interest, saying large farmland acquisition by big investors does raise concerns about the long-term benefits to local populations.

Food price rises and inflation risks have been cited as contributing to the unrest in Northern Africa and in other parts of the continent, such as Mozambique.

Source: CME News for Tomorrow

The Bottom Line: Western hedge funds are investing heavily in sub-Saharan Africa in the agricultural space. Their contribution has some impact on food price but not as volatile as others may claim.

Indian Ministry Continues to Defer Wheat Export Ban

2011-06-07T16:13:00.003-04:00

Unlike Russia, India still has not lifted its wheat export ban despite a nearly 2 year period of time having passed. Ministers are understandably concerned about volatile food prices in one of the world's most populous nations. There is less room for error compared to the former CIS states - the population of a single Indian province is more than the combined total of Russia. Except for limited exceptions the ban still stands.

Talking Points India Food Minister Favors More Time To Export Wheat Products
India's food ministry is in favor of giving traders more time for exports of around 500,000 metric tons of wheat products that were left unsold out of 650,000 tons permitted to ship abroad, Food Minister K.V. Thomas said.

India allowed private traders to export wheat products for a limited period in 2009 and the program was extended in phases until March 31, 2011 after the industry failed to meet the target. Roller flour millers have now sought time until March 31, 2012 to ship the entire quantity.

"We won't oppose [giving more time for] wheat product exports because we, in fact, encourage value-addition. So we may agree on wheat product exports, although we may not agree on grain exports," Thomas told Dow Jones Newswires.

A ministerial panel will decide on the issue, he added, but didn't say when the panel will meet.

Traders said a more-than-two-year ban until mid-2009 on wheat product exports resulted in clients shifting to other suppliers.

"India needs to have a long-term policy on wheat product exports and there should be no restriction on either the quantity or the period of exports," said Veena Sharma, secretary of the Roller Flour Mills Federation of India.

She said maintaining a ban on wheat exports will not only help ensure steady local supplies, but also keep down prices that will give an edge to India's exports of value-added wheat products.

Denmark, the Middle East, Indonesia, Sri Lanka, Nepal and the Maldives are the main buyers of Indian wheat products such as semolina and wheat flour that are used to make bread and bakery items.

India is expecting a record wheat output of 84.27 million tons this crop year through June, up from 80.8 million tons last year. Government officials say the final output may exceed the estimate by up to 2.0 million tons.

The country's food stocks swelled to nearly triple its buffer requirement of 59.13 million tons as of May 1, triggering speculation the government may consider limited grain exports to free up storage space.

But, Thomas said his ministry isn't in favor of grain exports as the government intends to enact a law that will widen subsidized grain sales to the poor. Still, India allows limited shipments to honor diplomatic requests from some countries.

India will export 250,000 tons of wheat to Afghanistan, out of which 100,000 tons have already been shipped, he said. It is also likely to ship to Bangladesh 300,000 tons of parboiled rice, approved in August 2010, within a month, he added.

Source: CME News for Tomorrow

The Bottom Line: India continues to behave cautiously in world grain markets despite a seasonal low in wheat approaching. Its large population and low per capita incomes make it vulnerable to supply shocks.

US Financials, Dodd-Frank, and Basel III Leverage Requirements

2011-06-06T12:01:00.003-04:00

Basel III added new rules to systemically important financial institutions last year but has particular importance for US based firms.

Basel III has another implication for US banks. Under the Dodd-Frank rules (still to be finalized) all OTC derivatives trading must shift to exchanges by a certain date. The U.S. Commodity Futures Trading Commission (CFTC) deadline for comment was this past Sunday (June 5) w/a final date of (early) July 2011 finalized.

Among lawyers, “Swap execution facility” (SEF) and “major market participants,” terms used in the Dodd-Frank Act, require further clarity from regulators. While financial firms continue to lobby about the definition of major market participants , their CFOs have quietly continued to accrue cash. For all those who follow the US financial sector and wonder why banks have been hoarding cash and underperforming look no further. The answer is margin.

Under the proposed rules, trading will thus become even more expensive for key players in the CDS market - particularly for banks and funds that work in the custom ("bespoke") finance world. While margin has always existed to some extent among financial institutions involved in OTC trading the rules were not transparent and often varied significantly across the board (e.g. AIG, Lehman Bros, Bear Sterns being notable examples of weakly applied internal rules).

The CME (Chicago Mercantile Exchange), one of the largest exchanges in the world, and the OCC (Options Clearing Corporation) have very clear rules on margin. It is after all, how they have managed to survive multiple financial crises for decades.

Earlier this year, market participants won an exception for Dodd Frank compliance rules but those were mostly w/respect to currency and agricultural derivatives hedging by multinational corps ("MNCs"). While they won exceptions in reporting requirements margin still needs to be posted because under the rules of an exchange, the exchange will make whole any counter-party losses. The CDS trade in sovereign, corporate, and junk (high yield or just HY for short) would be similarly affected.

And as readers here know margin is just another word for leverage. There are also major implications among the rules for the Treasury market. The short dollar trade is now popular among conventional wisdom but a sharp change in legal rulemaking could add to a countertrend rally.

The Bottom Line: Banks continue to accrue cash but have been underperforming this year because of regulatory uncertainty about new trading and reporting rules. In the absence of clear channels of communication they have bolstered their balance sheets to look more healthy than ever.

Another Look at the Chinese Shadow Banking System

2011-06-02T15:51:00.002-04:00

Here is a recent article on the Chinese "shadow banking system" and their efforts to move local government debt off balance sheet to the central bank. Please remember that the Chinese banking system and the Chinese government are the same things. Jokes aside about comparisons to the closeness of regulators and bankers in the US system, China continues to retain top level Party officials throughout business structures.

Now the Chinese are making plans to spin off some of this debt (once cleaned up) to private investors. (Hmm, I am reminded of TALF and the TOMO purchasing program of MBS by the Federal Reserve in the USA).

Meanwhile China's influence in the world markets continues to make its inflationary effects known in other shores by raising asset prices across the board. This goes back to the old inflation/deflation debate. If measured by asset prices, the West is experiencing inflation. But measured by credit the West is in deflation. In any credit based, fiat system there are hidden losses still lurking w/in the system. Losses from banking and housing based debt are still on the books. The real economy continues to be a miserable place for business owners and CFOs making hiring and R+D based decisions.

http://www.reuters.com/article/2011/05/31/us-china-economy-debt-idUSTRE74U26320110531

The Bottom Line: China's financial authorities are trying to head off a rise in bad credit among local institutions by soaking up the debt through the central bank. Inflation is real in China and most emerging markets. The existence of speculative bubbles and poorly planned loan issues is marked proof of overheating in capital infrastructure.

Emerging Market Inflation Indexed Bonds

2011-06-01T11:35:00.003-04:00

This is an older article but one that I believe is highly relevant. Inflation indexed bonds are typically thought of as US government treasury TIPS. But other countries are beginning to follow that trend by issuing their own inflation indexed debt. Specifically, emerging market investors remain eager to retain exposure to the sector but many are beginning to voice fears about inflation. Many emerging markets, such as Indonesia, have lost the old stigma of political instability and now have yields priced at or lower than Western European countries. But these yields are not protected or indexed to inflation. Food and fuel remain the largest and most volatile segments of most EMs' indices. The hawkish stance taken by many EM central bankers is eating into investor returns.

However, clouds loom on the horizon. Not all EM's are the same. The demographic dividends of some nations such as India and China are expiring. Wage inflation, briefly mentioned in other posts here, continues to rise. Turnover rates at Indian and Chinese firms is approaching 50%/year. The cost of training, hiring, and retaining workers is prohibitive - particularly when their clients in Western Europe and North America are largely unsupportive of price hikes. There will come a time when this slope of diminishing returns hits a wall of worry and economic growth cool down (my own belief is within the next 9-16 months). At that point, EM central banks may be forced to take a more dovish stance - including interest rate cuts.

http://www.ft.com/cms/s/0/d24fa4b6-501e-11e0-9ad1-00144feab49a.html

The Bottom Line: EM are beginning to offer inflation indexed bonds to investors worried about rising food and fuel prices eating into their returns. The trick however is to buy at a time when they believe real rates will come down.

Australian Government Bans Mining in Queensland

2011-06-01T11:01:00.002-04:00

The risk on trade just got more interesting. Two of the favored sectors - mining and agriculture are now competing for attention from the Australian government. Australian iron, coal, and other mineral exports have been a key source of the country's astounding growth vis a vis its relationship w/a resource hungry China.

Australia's Queensland To Ban Mining On Key Agricultural Land
The government of Australia's coal-rich Queensland state said it will prohibit mining on a vast area it considers the best land for crops, clashing with some in the mining industry who warn the move will deter investment.

Environment and Resource Management Minister Kate Jones released maps covering 4.78 million hectares, including much of southern Queensland, that she said will be granted protection. Mining and other development projects that aren't well advanced in the approvals process will now be subject to the legislation when it is introduced later in the year, she said.

"Through this policy, we are protecting our important food bowls across the state," Jones said in a statement. "New mining projects that will permanently render strategic cropping land unusable in the protection areas will not be able to go ahead."

She said the state government will soon release a draft planning policy to ensure approvals for development include appropriate consideration of agricultural land.

Queensland is the world's largest exporter of seaborne coking coal, with the Bowen Basin region accounting for almost 40% of global output of the raw material in steel production. Australia is expected to produce 163 million metric tons of coking coal and 232 million tons of thermal coal this year, driven by strong economic growth in developing Asian economies which is underpinning demand for steel, according to data released in March by the Australian Bureau of Agriculture and Resource Economics and Sciences.

The Queensland government expects its policy on agricultural land will be replicated in other states.

Neighboring New South Wales to the south last week placed an immediate 60-day moratorium on granting new coal, coal seam gas and petroleum exploration licenses in a move it said was aimed at striking a balance between agriculture, mining and energy. The government said all new drilling and mining applications would now need to include an agriculture impact statement and be opened for public comment.

The Association of Mining and Exploration Companies, an industry body, said the areas defined by the Queensland government for protection are so vast they will impede the mining industry.

"Queensland would be an economic wreck without mining, yet the state government seems determined to ignore the financial impact of ruling out mining across a massive area," said Ross Musgrove, state manager for the association. "This wholesale mining lockout will scare potential investors and raise doubts about the sovereign risk attached to doing business in Queensland."

Amec members include Anglo American PLC, Fortescue Metals Group Ltd. and Teck Resources Ltd.

Source: CME News For Tomorrow

The Bottom Line: Competing pressure to feed mouths and machinery have come to a head in Australia where the local government has banned mining. In the short term, supply constraints may tighten even more.

China Aims to Diversify Reserves in Agricultural Space

2011-05-27T16:29:00.001-04:00

Talking Points China Should Invest FX Reserves In Agriculture Abroad -Govt Researcher
China should use its huge foreign exchange reserves to expand investment in the agricultural sector overseas, in an effort to increase domestic market supply, a researcher with a government-owned economic institute said.

China's foreign exchange reserves, the world's largest, rose to $3.04 trillion as of the end of March, with a substantial portion invested in U.S. Treasurys.

China should build grain production bases abroad, especially in South America, Africa and some neighbouring countries with great potential to increase grain production, Chen Jie, a researcher with the Research Center For Rural Economy, a consultancy under the Ministry of Agriculture, said in an essay published in the state-owned Farmer's Daily dated May 21.

We must not rely on imports to meet domestic demand for grains," she said in the article.

"Otherwise, the issue of grain supply could become a national security problem anytime," he said, adding that cereal exporters could easily embargo trade in grains when supplies are tight.

Chinese agricultural companies are eager to tap overseas resources as domestic demand is rising quickly and domestic grain and edible oil production is approaching full capacity due to rapid urbanization.

Both the Chinese government and marketers also want to insulate prices from volatility in major markets such as the Chicago Board of Trade, and controlling upstream resources including land and crop selection would be the best way.

Local media have reported that the state-owned Chongqing Grain Group Co. to spend more than CNY2.5 billion to purchase land in Brazil for soybean cultivation, as part of a $3.4 billion plan to build oilseed and rice production bases overseas including bases for rapeseed in Canada and Australia, palm oil in Malaysia and rice in Cambodia.

The Tianjin-based Julong Group, a privately-owned palm oil trader and importer, has spent $200 million to buy 20,000 hectares of land in Indonesia to plant oil palm. The company plans to expand its oil palm planting area overseas to 200,000 hectares, with a total investment of $2 billion.

Meanwhile, China's state-owned Cofco Group is seeking to acquire Australia-based sugar producer Tully Sugar Ltd., competing with the New York-based Bunge Ltd.

China, the world's largest importer of soybeans and palm oil, is attempting to maintain a grain self-sufficiency rate above 95%.

Source: CME News for Tomorrow

Why Germany Should Learn to Love the Euro

2011-05-23T13:09:00.004-04:00

Have you ever wondered why German politicians are so supportive of the Euro? Besides attaching a great deal of their political currency (and hence careers) on the Euro, there is another more fundamental reason behind supporting the single currency.

Export subsidies. The Euro acts as an export subsidy for German manufacturers and exporters. But one may glance at the forex charts and say the Euro is so expensive! Not really - the Euro is very cheap compared to what the Deutschmark would be trading at now. Remember that Euro trading prices in factors such as deterioration of the peripheral PIIGS countries.

The Euro is also a blessing in another guise. In continental Europe, economic activity has always gravitated towards the center - in particular to Germany. The EU is a 2 engine economy led by Germany and (and to a much lesser extent) France. Wage growth is being kept relatively low by migrant workers from Eastern Europe and the periphery imposed legally per the EU treaties.

The last blessing in disguise is the German consumer and investor's rise in purchasing power. Sure, the EU is in horrid economic shape but the Euro is still trading at a premium relative to the dollar. As a result, things are cheaper for travelers and asset managers who wish to engage in speculative carry trading.

The Bottom Line: German taxpayers may grumble about the Euro but the elites have, ironically, their best interests at heart.

Emerging Markets' Biggest Threat is Deflation - Not Inflation

2011-05-23T13:07:00.001-04:00

Brazil and other emerging markets are also leveraged in another way - to the dollar. The commodities trade in particular for exporters is prone to violent swings. Oil and many agricultural products are tied to benchmark rates set on the CME and CBOT in the USA b/c futures contracts continue to be priced in dollars. Recent margin hikes on oil and precious metals are warning signs to me to contain volatility. For Brazil, agricultural commodities are capped w/lock limit prices on the Chicago exchanges so volatility won't come from that corner. Instead it will come from base metals traded on the LME like copper (see prior article about China and copper for a more reasoned explanation).

The long term fundamentals of supply and demand for agriculture are expected to remain strong for the next several years -supportive of continued inflation of land, inputs and machinery.

But what comes up must come down. Demand destruction is real - the world cannot survive for long on oil >$100/barrel and oil is considered a leading industrial indicator. The velocity and supply of money has turned from a stream into a river in many developing countries. Some of this can be attributed to Western investors but a lot more is sourced from the native governments.

The biggest culprit I see now is China - M2 has jumped despite efforts by the PBOC to play games (http://ftalphaville.ft.com/blog/2011/03/21/520846/chinas-missing-m2/). M2 is STILL up b/c the Politburo has focused its efforts on blaming Western foreigners (US and British investors) instead of looking in the mirror - the explosion in money supply is due to FORCED domestic lending by banks from the 2009 stimulus effort. Simply put, loans are being made to people who should not be receiving them - all in the effort to keep employment high.

China's leaders are following this policy b/c they value social stability above all. But the policy is ruinous and leading to a credit bubble. Already we are seeing signs of a coming deflation in wage growth. I was reading in the Financial Times where the reporter stated China and India are leading the world in wage inflation by repeatedly raising minimum wages . In the short term that is a good policy to have - but the 2 countries are already losing their competitive advantages to smaller, cheaper players like Vietnam, Philippines, and Indonesia.

Conclusion: Emerging markets' biggest threat now is deflation - NOT inflation. The current runup in inflation is due to a massive increase in credit since the Lehman bubble popped in 2008. But this rise in inflation is only short term - it will pop as over-capacity in capital stock comes downstream. Politicians are stuck between choosing growth or choosing inflation. Instead the choice will be made for them by the markets. I predict a hard landing for many markets w/in the next 9-15 months, 2013 by the latest.

European Wheat Weakness

2011-05-20T21:13:00.004-04:00

Any strength in bullish prices can be tempered by the seasonal weakness in associated equity markets. In a POMO liquidity driven world, computer trading has followed into commodities to push prices higher.

European Wheat Prices To Revisit 3-Year Highs On Drought-Analysts
Forecasters and traders said wheat prices could hit the three-year highs touched in February if drought in Europe and the U.S. continues to stress next year's wheat crop.

New-crop wheat prices have gained sharply this week, hitting three-month peaks of EUR251.50 a metric ton on the November Paris milling wheat contract on Thursday, driven by concerns next season's harvest could be irreparably damaged.

But now analysts say the current bull run may continue, taking futures above the near-record highs of EUR281/ton touched in February as the worst drought in decades tightens its grip on Europe's fecund farmland.

"I think there are still significant risks that wheat prices could push back to the highs we saw in February if weather doesn't improve in the coming weeks," said Erin Fitzpatrick, an analyst at Rabobank.

Production expectations for next season are falling by the day as drought across key growing regions of France, Germany, the U.K. and Poland--which account for 65% of EU-27 output--wilts the young crops in the fields.

Parts of Europe received less than 40% of their average rainfall between February and April and analysts now say up to 12% of France and Germany's crop will be lost even if rain does arrive.

"If we do not get the right mix of rain and sun in the coming 8-10 weeks, then later this year we will see record price levels," said Charles Robertson of Renaissance Capital.

Concerns about crops in the U.S., Australia, Canada and Russia are also keeping the market nervous. Last year's rally was sparked when an historic drought in Russia prompted the Kremlin to ban exports and take tens of millions of tons of the world's cheapest wheat out of the international market.

Although initially delayed by poor weather, at the end of last week Russian farmers had planted spring crops on 18.921 million hectares, only 4.5% less than on the same date last year, the Agriculture Ministry reported.

In forecast generally regarded as over-optimistic by the trade, the U.S. Department of Agriculture last week forecast that wheat exports from the Black Sea region, including Russia, Ukraine and Kazakhstan could double to more than 26 million tons in 2011-12.

But Eugen Weinberg, analyst at Commerzbank, said with weather so unpredictable at this stage, any production estimates are very much uncertain until the grain is in the storage bins.

"We're still in the development stage," he said. "The troubles last year only came in June to July.

"EUR280/ton is definitely on the cards at the moment."

Source: CME News for Tomorrow

China, The IMF, and Dominique Strauss Kahn

2011-05-17T18:50:00.004-04:00

What do China, the IMF, and Dominique Strauss Kahn ("DSK" hereafter) share in common? Most media have become transfixed by front page coverage of how the now disgraced banker's political career was destroyed by a low paid, immigrant maid. Rather than go into the increasingly lurid details, of which many other sources are covering, I will attempt to explain the potential ramifications on the IMF and China.

There is now a power vacuum in place at the IMF. While an interim head has been selected, no permanent selection mechanism has been activated. Instead, we are witnessing an intense, behind the scenes political jockeying for power and influence that stretches around the globe. I speak of course about China and her ambitious rise to prominence.

For years, the IMF has been dominated by a succession of figures chosen from the ranks of Western European and American financial and government elites. The selection process is a delicate balance that in theory has a foundation in its quota system. Quotas are broad reflections of member states' econonomy. Dues or quota subscriptions are 25% paid in a major international currency (e.g. typically $, Euros, or yen w/the dollar being preferred) and the remainder 75% in their own currency.

The quota system for emerging economies was raised in April 2008. The system is reviewed every 5 years - w/the next review having been completed earlier this year (2years ahead of schedule) in January.

So, how does the above apply to China? January is not so far away from May that a re-assessment may be called for by some members on the governing council. China's has strong incentives to get a native representative (or at least someone loyal to Beijing's cause). In 2010, China surpassed Japan to become the world's second largest economy. In 2011, she remains the world's most populous state. Chinese loans are supporting the economic backbone of the West - a teetering EU and a profligately consuming USA. It is w/regards to American spending that this tense dynamic that is currently underscoring international trade and public policy.

In multiple speeches during the past two years, Chinese officials have repeatedly voiced their concerns about the viability of the dollar's role as a reserve currency.

Open calls to American politicians to preserve the value of their investments have been ignored. Actions always speak louder than words and while US officials publicly support a strong dollar policy their actions speak to the direct opposite. China is not entirely w/o fault however as Congressional calls for China to revalue the renminbi have an air of truth about them.

One interesting angle of critique has been the proposal for a new SDR currency that would place the renminbi among the basket of currencies allowed to be held in the 25%quota.

Besides the symbolic value, a Chinese Managing Director (CMD) of the IMF would secure substantial political leverage against the American's weak dollar policy and ensure a margin of security against Congressional voices against a strengthening renminbi. From the IMF's podium, the CMD would be able to issue damning critiques against the Federal Reserve and US Treasury w/the full force of international law (for what that's worth).

A more focal point is the IMF's control over the purse strings of emergency bailout loans to sovereigns. The IMF has historically made loans to developing nations (formally referred to as the 3rd world). If a global cooling in commodity prices does occur, these emerging market nations that have been the recipients of so much hot money would face capital flight and enormous political/economic devastation. China itself has been pumping large amounts of capital into sub-Saharan Africa, Latin America, and South Asia. A CMD would be able to direct the organization to help offset any losses the Chinese state would suffer on these investments. More ominously, the day may come in the not so distant future that the IMF's funds may be directed in the explicit bailout of a Western European or (and previously unthinkable) America itself.

But it is not so cut and dry. The United States has a major say in determining who will head the IMF, in part because it holds the largest number of votes at the 187-nation international lending agency, in the quota system. Both sides have likely begun marshaling allies to support bids for respective candidates.

The bottom line: DSK's fall from grace is not the main story. China has been lobbying for years to obtain a stronger international voice. Placing a Managing Director favorable to Beijing would ensure it greater leverage against the USA.

A Penny Saved Is Not a Penny Earned: Copper Pricing and China

2011-05-16T12:13:00.006-04:00

"A penny saved is a penny earned" is a famous quote from American Founding Father, Benjamin Franklin. However, this maxim is hardly true today - the modern penny having been diluted by a 97.5% base of zinc and a thin copper covering of 2.5% after prices had become too expensive.

Copper is an industrial metals bellwether and more importantly, a risk on trade bellwether (dollar down/risk on assets up). Unlike oil, which has a substantial political volatility premium built into its pricing, copper's output is constrained by mining difficulties. Both commodities take years for efficient resource extraction, but base metals had been comparatively neglected in the past 2 decades compared to energy.

Consequently, any fall in copper prices are likely to be due to falling demand as opposed to speculative swings in prices. Technicians can see this trend outlook in the MACD in the above charts.

Compare copper to the volatile price swings in other risk on assets such as gold and silver. While precious metals retain intrinsic value in preserving wealth they had also taken on bubble like characteristics in recent months - just look at silver's dramatic rise to near $50/ounce before its violent 1 week correction earlier this month. Of course, no discussion about copper would not be complete without mentioning China.

China has been the biggest source of demand for copper with anecdotal reports of manufacturers stockpiling the shiny metal in warehouses. But authorities have been on a decidedly hawkish stance since last year with persistent interest rate increases and bank reserve requirements. The renminbi has also been allowed to appreciate the most in its history - by differing accounts from between 3.5% - 4.5%. This rate rise may sound small compared to swings in other currencies but remember that China's exchange rate remains tightly controlled for political and economic reasons.

An appreciation on the order of AT LEAST 5% is needed to be effective in constraining runaway inflation. Official inflation rates for April 2011 were 5.3%. Real inflation rates are estimated to be much, much higher - on an order in the double digits. Volatile food and energy costs are estimated to comprise much of this increase. To be truly effective in constraining price pressures, Chinese authorities would have to allow the renminbi to appreciate to double digit percentage levels. Of course, this will never happen. Allowing the currency to appreciate to such levels would devastate the export manufacturing sector and lead to a massive loss of jobs.

The Chinese government is left w/alternative policy controls such as raising bank reserve requirements, hiking margin on stock exchanges, loosening currency flow restrictions (e.g. allowing renminbi denominated accounts to be opened elsewhere outside Hong Kong), and allowing wage increases among broad swathes of the employment sector (more on this topic in the next post). These methods have had varying levels of success in cooling the economy. One thing is certain though: as inflationary pressures continue to rise, Chinese authorities will ultimately be forced to allow the renmimbi to appreciate to higher levels.

The bottom line:
Bulls on risk on assets are now engaged in a fight w/the Chinese central banking authorities.

The Shadow Banking System in Emerging Markets

2011-05-14T19:15:00.010-04:00

Shadow banking. These two words have come to encompass everything that was wrong about the 2008-2009 financial crisis. Shadow banking was first used by Paul McCulley of PIMCO in 2007 to describe the giant "soup" of non-depository institutions but later popularized by supremely bearish economists such as Nouriel Roubini in 2008 (then among a small list of contrarian opionists) to include all forms of financial institutions like hedge funds, insurance companies, and investment banks. But this term is not just confined to the West.

The superficial forms may be different but the underlying structures and intent - off balance sheet money creation - remain just as potent in a broad swathe of regions ranging from Latin America to the Middle East, Far East, South Asia, and Eastern Europe (including the CIS countries).

Most economists ignore these capital flows b/c it is hard to capture systematic data on such a diverse group but their influence is equally hard to dismiss - surging inflation, and frenzied speculation on (insert favored asset class of the month - real estate and stocks remain favorites but other speculative targets include precious metals, art, jewelry, and even wine). Sources include remittances from foreign workers and family, off the book transfers to SOEs (state owned enterprises), grey market additions or subtractions on trade letters of credit, unofficial lending systems like "hawala" prevalent in many Muslim communities, and even funds from organized crime syndicates.

I would argue that in some cases (depending on the country's level of official financial innovation), these flow of funds can surpass the volume of funds issued by the central bank and can add huge pressure. While the individual actors in the system may be small their collective impact is overwhelming. Certain regions receive their funding sources from a small but dominant group. For example, Latin America tends to receive a huge number of remittances, so much so that in countries like Mexico, remittances are the number 1 or 2 (depending on whose counting and what political agenda they may have) source of GDP growth. In other states with Communist backgrounds (the CIS, China, Vietnam), off balance sheet transfers to SOEs are prevalent.

An additional note about China. Due to its enormous size, China has a proportionate impact on global levels of supply and demand, and - despite protestations of party officials - inflows and outflows of money. For years, the fixed (now tightly managed band) exchange rate contributed to all sorts of games played by exporters and importers on letters of credit, the trade documents that serve to lubricate wholesale trade. Parties to a transaction would routinely mark up or down their costs at the behest of their partners (usually for tax reasons) but also to import additional funds beyond the official limits. China also has its SOE legacy. It is hard to imagine now, but China used to be a Maoist state in every sense of the word. Money losing ventures in (sometimes) obscure parts of the country would produce goods for the sake of producing goods. These operations have more or less ceased to exist but their "losses" remain on the country's financial balance sheets (no one is really talking at Beijing much about this problem - did you really expect transparency from an authoritarian state?). But by some independent accounts, the scale of losses on these operations rivals the deflationary collapse in 1980s Japanese real estate.

Halwa, or the unofficial Muslim money transfer network, deserves special mention. The system incorporates scores - if not hundreds - of semi-independent brokers interwoven in a complicated network of trust. Deals are sometimes made on nothing more than handshake and accounts kept in paper ledgers. On this framework alone, funds can be sent from the rudest mountain village to the shiny cosmopolitan cities of Europe and North America. The system was developed in an effort to frustrate medieval tax authorities but was also molded in the cauldrons of internecine conflicts (called "brush wars" by Western analysts) when funds needed to be quickly sent and official lines of communication had broken down.

Organized crime has a special place in the role of money creation and transfer. It is prevalent in every society but really flourishes in regions where the rule of law is weak or more sinisterly, incorporated, into elements of the government. Profits from illegal activities such as the narcotics trade, piracy, human smuggling, prostitution, arms trafficking, counterfeiting, and credit card fraud (to name but a few sources of revenue) contribute unofficial amounts to GDP growth. The funds are sent through multiple channels - some of it is laundered to foreign operations and some of it is spent at home. The ruthless intelligences directing these funds make organized crime figures some of the shrewdest and most efficient capitalists of all. In their own ways, crime lords provide a source of jobs and growth to regions unmatched by official government stimulus efforts.

The sum effect of all this additional money sloshing around the globe is the same as that created by official government sources. The effects are currently inflationary, buoyed in large part by the interplay between central bankers - the doves of the West and the hawks of, well, everywhere else. But the pendulum can easily swing the other way - prolonged periods of economic malaise can send foreign workers packing back home and a key source of remittances would dry up. The same applies to cases of trade finance where importers and exporters depend on certain assumptions underlying their relationship - cheap, unofficial subsidies and exchange rates to artificially boost buying power. Even successful law enforcement efforts to clean up crime can have a short term deflationary effect on local economies.

The Bottom Line: The Shadow Banking system operates all over the world and should not just be applied to cases of large sophisticated fund managers. The collective force of many small actors can be enough to rival or even surpass official authorities. The global sloshing of funds is currently tilted firmly towards the inflationary camp but may swing the other way due to macro-economic developments in the West.

Mississippi Flooding Threatens US Food and Energy Stockpiles

2011-05-10T19:04:00.005-04:00

More upwards pressure is being exerted on the price of food and fuel - the twin drivers of inflation and excluded from the highly sensitive "core inflation" metrics used by the Federal Reserve. Record flooding from the Mississippi River along w/holdover damage from the Tornadoes that swept through the American South several weeks ago are pushing commodity prices higher. But readers should take note that inventory levels of energy also reflect seasonal and historical trends. Also of note is this Friday's April Core CPI numbers which are expected to show an increase in headline inflation.

See here the EIA's natural gas storage analyses: http://ir.eia.gov/ngs/ngs.html

The US Dollar remains quite oversold in comparison to the Euro and Yen. Dovish central bank sentiment in Brussels and Tokyo have pulled the two major crosses back against the dollar in the past week. Another short term correction in the dollar is possible.

Crops, Oil Refineries Threatened By Mississippi River Flooding
The surging Mississippi River is flooding hundreds of thousands of acres of farmland and limiting traffic along the waterway, delaying fuel shipments.

Fields of recently planted corn, cotton and soybeans along the Mississippi Delta were inundated as the river overflowed, government officials said. Soaked soil is forcing thousands of other farmers to delay plantings this year.

"I really can't compare it to anything. This is unprecedented territory right here," said Andy Prosser, head of marketing at the Mississippi Department of Agriculture and Commerce.

The real problem for growers will be when the waters recede.

"They don't know what kind of sand or silt, debris, may have been deposited on their farmland," said Tom Womack, a spokesman for the Tennessee Department of Agriculture. He estimated that 500,000 acres are already underwater in the state.

The waters are likely to have washed away seeds and mineral-rich topsoil. The U.S. Department of Agriculture has said U.S. stockpiles of key crops such as cotton and corn are at or near historic lows, due to rising global demand.

July corn futures recently traded 1.2% higher on the Chicago Board of Trade, at $7.15 1/2 a bushel, while July delivery soybeans were up 0.7% at $13.44 a bushel. Cotton futures for July delivery were up 0.6% to $1.4631 a pound on IntercontinentalExchange.

The surging river is also threatening energy production and transport throughout the South.

Oil refineries are bracing for potential shutdowns and disruptions to fuel shipments ahead of the floodwaters now moving toward the Louisiana refining corridor. Motiva Enterprise LLC's 237,000 barrel-a-day Norco, La., refinery is preparing for supply disruptions due to the opening of flood gates, according to a spokesman for Royal Dutch Shell PLC, which is part of a joint venture operating the plant.

Fuel products such as gasoline and diesel are distributed through pipelines, rail links and tankers. The floods, which have already stalled some river traffic, could also force companies to halt pipeline flows or lead to congestion on railroads.

U.S. gasoline stockpiles have fallen for 11 straight weeks, and analysts expect further declines in data due for release by the Energy Department on Wednesday. The floods, should they curtail refining in the region, could help push average U.S. retail gasoline prices above $4 a gallon, straining the budgets of consumers and businesses and potentially weighing on the economic recovery.

The bottom line: Markets remain nervous about food and energy price runups. While they suffered a short term drop in last week's trading, the fundamentals remain bullish - but not to the extremes as espoused by some bulls. The short dollar trade is still very crowded and the currency may experience another rally that could dampen bullish commodity prices.

Source: CME News for Tomorrow

Late Spring 2011 US Agricultural Outlook

2011-05-10T18:19:00.003-04:00

US Crop Progress: Farmers Make Huge Strides In Corn Planting
Farmers made huge strides planting corn in the western Midwest last week after cold, wet weather delayed earlier field work, according to government data.

The crop was 40% planted as of Sunday, up from 13% a week earlier, the U.S. Department of Agriculture said in a weekly crop progress report. That beat expectations that plantings would be about 30% complete but still lagged the average of 59% for that time of year.

Warmer, drier weather in the western Corn Belt allowed farmers to make significant progress. In Iowa, the country's top corn-producing state, farmers had sown 69% of the crop as of Sunday, up from 8% a week earlier and on par with the five-year average. Farmers had planted 57% of the crop in Nebraska, up from 15% a week earlier and behind the average of 62%.

"We made some historic strides in Iowa. You planted 61% of the crop in just a few days," said Don Roose, president of U.S. Commodities, an Iowa-based brokerage firm.

Yet, farmers in the eastern Midwest continued to struggle with poor weather. Indiana's crop was just 4% planted as of Sunday, below the average of 49% for that time of year, and Ohio's crop was 2% planted, below the average of 54%, according to the USDA.

The lack of progress in the eastern Midwest will likely keep the corn market on edge, as traders worry that planting delays will reduce the size of next fall's harvest, Roose said. Traders will continue to watch weather forecasts closely for signs of improving weather.

Development of the crop also still lags behind normal. Overall, 7% of the country's corn had emerged as of Sunday, up from 5% a week earlier and below the average of 21% for that time of year, according to the USDA.

Farmers need to harvest a large crop next fall to replenish inventories that are expected to drop to a 15-year low this year. Concerns about strong demand draining supplies pushed corn futures to record highs last month.

"It truly is the eastern Corn Belt vs. the western Corn Belt," Roose said.

Farmers are less concerned about planting soybeans because that crop can be sown later in the spring without risking yield losses. Corn tends to produce lower yields in many areas if it is planted past the middle of May.

Soybeans were 7% planted as of Sunday, below the average of 17% for that time of year. In Iowa, 10% of the crop was in the ground, behind the average of 18% for that time of year. The USDA did not report nationwide data for soybeans last week.

Spring wheat planting also advanced after a slow start due to cold, wet weather in the northern Plains. Planting was 22% complete as of Sunday, up from 10% a week earlier and down from the average of 61%.

In North Dakota, the top producer of spring wheat, farmers had planted 7% of the crop, up from 1% last week and below the average of 51%. More progress was made in South Dakota, where planting was 59% complete, up from 22% a week earlier and below the average of 85%.

Spring wheat, prized for its high protein content, is milled into flour used to make bread and blended with other, lower-quality varieties of wheat. Users of the grain worry farmers will sow fewer acres of spring wheat than previously expected due to the planting delays.

The condition of winter wheat, meanwhile, continued to deteriorate due to a severe drought in the central and southern Plains. Overall, winter wheat was rated 33% good to excellent, down one percentage point from last week and from 66% a year ago. In Kansas, the country's top winter-wheat-producing state, the good-to-excellent rating dropped to 18% from 21% last week. Kansas and other Plains states grow hard red winter wheat, which is milled into flour used to make bread.

The bottom line: More progress in planting is a bearish leaning sign for corn as uncertainty about crop levels is being reduced. Selloff potential is limited by the steep losses seen yesterday and last week. But conditions for soybeans and wheat remain below normal for this time of year.

Source: CME News for Tomorrow

Could Brazil Run Out of Ethanol?

2011-05-06T16:07:00.002-04:00

Corn is currently heading into a seasonal downtrend in summer trading where contracts reflect increased certainty about crop planting. However, longer term fundamental effects continue to add upwards pressure on prices. A lack of investment in technology and continuing high energy use are contributing to high prices.

The Brazilian-USA ethanol trade relationship is somewhat complicated. Due to tariffs, Brazilian exporters have long sent ethanol to the USA - but doing so through intermediaries in the Caribbean which benefit from sunny tax treatment by US tax authorities. The US tariff is meant to protect US corn farmers. At long last, Congressional (or should I say, lobbying) efforts have paid off. Brazil is currently about to enter a short to medium term decline in ethanol production.

Czarnikow: Brazil Could Run Out Of Bio-Ethanol
Brazil could potentially run out of ethanol supplies, needing a further 100 million tons of cane to meet peak demand in 2011, one of the U.K.'s oldest sugar trade houses said.

"As a result of ethanol output disappointing for the second season in succession, supply has been unable to match the rise in demand resulting in a chronic shortfall in availability," Czarnikow said.

In Brazil, a lack of new investment in cane production, rising sugar prices and production, and underlying weaknesses in the earnings structure resulted in ethanol production falling short of 2010/11 forecasts, reaching only 25.3 billion litres, only 3% higher than 2009/10.

In Europe, member states face supply issues given the implementation of higher blend rates as the European Union targets to source 20% of energy from renewable sources by 2020, Czarnikow said.

But Czarnikow analyst Henry Toller said despite the bio-ethanol market facing challenges to expand, the history of the market since 2003 shows growth is always achievable.

The U.S. meanwhile has swung from a net-importer to exporter over the last 18 months, to become the most reliable hub of ethanol supply for other nations.

Czarnikow estimates that U.S. exports will continue in 2011 as U.S. production now exceeds gasohol demand by 5%. "Even Brazil has had to turn to the U.S. to supply ethanol due to the temporary shortage being faced in its domestic market today."

Source: CME News for Tomorrow

The Bottom Line: Brazil, long a chief exporter of ethanol, is running short on production due to a lack of investment in technology. At the same time, US corn farmers are benefiting from high prices and the tariff imposed by tax authorities. In fact, Brazil may have to turn to the USA to import additional supplies.

Mexico Buys 100 Tons of Gold in First 4 Months of 2011

2011-05-05T20:20:00.006-04:00

Here's another story on Mexico.

In 1521, Hernán Cortés, the Spanish conquistador, conquered the Aztec empire which encompasses modern day Mexico. Over the ensuing centuries, the Spanish crown systematically looted the land of its gold and silver reserves.

Fast forward to today. In a surprise announcement, the Mexican government revealed on Wednesday that they had been slowly acquiring a substantial horde of gold bullion. The sheer amount of gold bars is enough to rival the Aztec treasures of old - more than 100 tons of gold w/an estimated market value of $4 billion.

While the number of gold bars is enough to raise eyebrows, of more importance is Mexico's proximity to the USA. Mexico is America's second largest trade partner w/an economy highly linked to the dollar. As a developing nation largely dependent on exports and tourism to support its economy, Mexican authorities had built a substantial foreign reserve horde that enabled them to systematically sell the peso against the dollar.

Nor is Mexico the only country to do so. China, India, Russia, Kuwait, Saudi Arabia, and (to a lesser extent) Brazil, have been incorporating more gold into their central reserves.

However, there is an important distinction to note. The above countries are all DEVELOPING states, which is a broad term and somewhat politically loaded; but for purposes of this discussion mean their primary source of GDP growth is centered on exports. Central banks in such countries acquire foreign reserves to manipulate exchange rates thereby keeping exports cheap for Western consumers. Authorities have generally refused to comment on the official reasons behind their purchases but are widely believed to have done so for diversification away from the dollar and the inevitable debasement into inflation being wrought by America's uncontrollable spending spree.

Other countries, particularly DEVELOPED states such as the UK or more tellingly, Japan, have smaller gold reserves. But they are not necessarily buying gold either. Instead, these states tend to have well established links w/the Federal Reserve in the form of dollar swaps. These swaps are there not for currency manipulation but to pursue Keynesian monetary policy, aka money printing to support capital markets and failed bankers. This is not a specious charge. Major swap partners include Japan w/its notoriously underwater real estate market that has still not recovered from its 1980s highs. Another notable example is the EU w/its plethora of PIIGS peripheral (impending) sovereign bond defaults.

The bottom line: Developing countries such as Mexico have been acquiring gold bullion as a diversification against the dollar and inflation. But developed states have no reason to do so, instead relying on dollar swaps w/the US Federal Reserve to achieve their Keynesian goals of propping up underwater loans and mortgages.

Sugar Faces Potential Extra Supply

2011-05-05T16:05:00.003-04:00

Mexico is not exactly the first place that comes to mind among sugar traders. America (sugar beets and corn), Brazil (sugar cane), and India (sugar cane) are all more known sources. But when prices surge high enough, as they have been over the past 2 years, farmers around the world start paying attention.

Of greater import is the significance behind the dollar's role as the preferred carry instrument of choice. More will be said on this topic in future posts.

Mexican Sugarcane Growers Upbeat On Next Harvest
The leader of Mexico's sugarcane growers says he's optimistic the 2011-2012 harvest will yield more sugar that the current one if the weather holds up.

"If the upcoming season is a normal one with tropical storms and a few freezes, but less aggressive than this year, without a doubt we're going to surpass the current harvest," Carlos Blackaller, president of the National Union of Sugarcane Producers, said in an interview.

High sugar prices have been luring Mexican farmers of other products into the sugar business, he said. Also, productivity has been increasing as well-financed producers use profits from high prices to hire more labor and to invest in improved agricultural practices.

This should contribute to better production next season in Mexico, the world's sixth-largest sugar producer, Blackaller said.

Mexico's sugar harvest usually begins in November and runs to July of the following year. This season, Mexico is on track to produce about 5.2 million tons of sugar, up from 4.8 million tons during the 2009-2010 season, according to sugar officials.

The average yield of sugarcane per hectare has been about 67 tons this season, and it could reach 70 tons next season, Blackaller said. He added that about 37% of plantations are using irrigation systems rather than relying on rainfall, and that percentage is expected to keep growing. Four years ago, about 30% of sugar plantations were irrigated. "There's a better use of water," Blackaller said.

Rene Martinez, director of the national sugar chamber, which represents the country's sugar mills, was less optimistic about the 2011-2012 harvest, saying it didn't rain when it should have in January and February during planting for the next harvest.

"It's an indicator that the 2010-2011 season will be a hard one, with production probably lower than this season's," Martinez said. "Normally when you plant, you cross your fingers and hope for rain, and since it didn't rain we're expecting bad yields."

Blackaller said industrial productivity has increased roughly 6%, and that many of Mexico's 54 sugar mills have been renovated and improved as their owners seek to take advantage of the bullish market.

Migration has been a problem in the sugar industry in the past, with growers abandoning their plantations to find work in the U.S. or in Mexican cities. But this year, Blackaller said high prices have kept producers "rooted to their plantations."

Mexico is expecting to export a record 1.3 million tons of sugar this year amid rising U.S. demand and the displacement of domestic sugar consumption with high fructose corn syrup.

Source: CME News for Tomorrow

The bottom line: Extra sugar supplies are adding bearish pressure to world markets from unexpected corners. The dollar's role as a funding currency in carry on risk trades also plays a critical role in commodity trades.

Update on Silver: SLV Fund Sells 7.59 Tons of Silver

2011-05-03T19:05:00.003-04:00

Remember my earlier post about backwardation and contango? Here's an update.

As to why the SLV fund is liquidating its physical holdings, look to the fund prospectus which basically states that if SLV has more shares short than long, then it will trade to the downside. In this situation its custodians must buy back SLV shares to absorb the excessive supply to get back to its tradable NAV. To do so, fund managers must sell some of their physical silver bullion thereby equalizing SLV selling into silver itself. This activity is magnified in levered funds such as AGQ.

Silver holdings in the iShares Silver Trust (SLV), the biggest exchange-traded fund backed by silver, decreased 7.59 metric tons to 11,013.75 metric tons as of May 2, according to figures on the company’s website.

http://www.bloomberg.com/news/2011-05-03/ishares-silver-trust-holdings-decrease-8-metric-tons-table-.html

The bottom line: Read the fund prospectus before investing any funds into levered ETFs. There is a lot of money to be made on both the long and short sides but be sure to have a SOLID understanding of how they work. I cut my teeth on the 2008-2009short etfs and paid my dues then. I can see the same thing happening in other instruments now.

Opinion: Russian & Indian Wheat Exports Unlikely to Lower Prices

2011-05-03T18:42:00.003-04:00

Wheat prices have remained at elevated prices ever since the dramatic runup in late summer 2010. Prices have remained high due to not only Federal Reserve money printing but also fundamental conditions. While North and South America remain affected by La Nina dry weather conditions, buyers have also been hopefully waiting for Russian and Indian exports to open since both countries banned exports (Russia last fall and India 3 years ago). Recent speculation that the two countries would relax controls have not done much to dampen the mood among some bullish speculators.

Of more importance to grain market speculators are the results of moisture conditions in the US midwest region (namely Kansas where hard red wheat is grown). Preliminary reports from scouts indicate that the region has received some rainfall but not as much as expected.

Russia, India Wheat Exports Won't Calm World Markets - Analysts
Deteriorating prospects for U.S. and European wheat crops mean even the return of exports from Russia and India to world markets this year would be unlikely to lower prices, analysts said.

Futures markets for the world's second-most consumed grain have soared to within sight of record highs this year after a succession of natural disasters, including a historic drought in Russia, spurred fears of a shortage of supplies.

But now even hopes that India will ship its first wheat abroad in five years and speculation that the Kremlin will lift a ban on Russia's exports as early as this summer look unlikely to calm nervous markets.

"We don't expect that the Black Sea region will be able to come into the market in the way it did after the 2008 price rally to supply the world with a significant amount of cheap exports," said London-based Rabobank analyst Erin FitzPatrick.

Grain dealers in Russia are starting to move stocks to ports in the hope that the government will allow exports as early as July. Forecasts for Russia's 2011-12 exports range from around 3 million tons to as high as 10 million tons.

Dmitry Rylko, of Russian forecaster Institute for Agricultural Market Studies, said dealers are hoping to free up storage space for the upcoming harvest. But Russian traders said companies are positioning grain in a bid to ship supplies quickly as soon as the ban is lifted.

"I would assume the Russians want money quickly so, if they can sell, they will sell as soon as they can," said analyst James Dunsterville of Switzerland-based Agrimoney.

In Asia, the U.S. Department of Agriculture's attache predicts that a record wheat crop of 84.2 million tons may prompt New Delhi to allow up to 2 million tons of exports, the first time in five years India would export grain.

Still, with food security concerns high on the political agenda in both countries, a sudden surge in shipments looks unlikely.

Both Russia and India are struggling with near double-digit inflation despite holding excess government grain supplies in some areas. And with polls already under way in India and an election set for next year in Moscow, observers say domestic politics is likely to come ahead of international markets.

Even exports from these producers are unlikely to make up for a fall in output in the U.S. and Europe. Wheat prices have rallied more than 20% since April 16 due to concerns for harvests in the world's two largest exporters as dryness has stressed crops in the ground and excessive rainfall has hindered planting.

Source: CME News for Tomorrow

The Bottom Line: Wheat prices are likely to remain elevated despite the possible re-introduction of Russian and Indian exports due to fundamentally bullish conditions.

How Low Can the Dollar Go?

2011-05-03T16:47:00.004-04:00

So, just how low can the dollar go? Above are some technical charts detailing potential price movements. If you are a subscriber to Point and Figure chartology, there is even a price target.

On the fundamentals, the prospects for the dollar remain decidedly weak. In fact, there is a strong consensus in Washington D.C. - both among the Federal Reserve and elected officials in Congress to keep the dollar low. Their thinking is based on the premise that so long as the dollar continues to slide there will be great benefits to large American firms increasingly doing business on foreign shores, with particularly strong growth for those moving product in emerging markets. Additionally, interest rates must be kept low for borrowers to keep on making their payments - or more correctly, for the owners of MBS assets to keep on receiving their income streams. The all time lows were established in the pre-crash environment of summer 2008.

Discerning readers may note that the mention of 2008 mean that the market is set to crash again. This is not entirely untrue. However, the main difference between 2008 and 2011 is the level of government involvement in the market. The Fed is basically acting as a giant backstop to all risk on trades w/giant liquidity pumps. While markets may certainly experience corrections, they are unlikely to test the volatility swings seen in 2008.

The US Treasury Department noted this week that it is taking some steps towards responsible FISCAL policy. But this does nothing to alter the Federal Reserve's MONETARY policy. Quick summary - US finances are divided between monetary and fiscal policy. Monetary policy is controlled by the "Treserve" (Treasury + Federal Reserve). Fiscal policy is controlled by Congress (the power to tax and spend). Usually. This line of demarcation has been gradually blurred ever since 2008 and the alphabet soup of bailout programs. The latest announcement by the Treasury is aimed at cutting off subsidies towards state and local governments, hence the fiscal aspect. In contrast, talk of deficit limits are aimed at reigning in Fiscal policy among Congress which decides each year's budget. All of which are going nowhere fast and does nothing to alter the basic preserve of US politics - that in a pork barrel political world, politicians get voted into power based on how much they spend - not how much they cut.

Throw in the addition of Japanese monetary policy (estimated at $250-275 billion last month alone) and the world is easily awash in liquidity several times over. All of this excess cash seems set to continue raising all risk assets several times over - even in spite of the pain dealt to savers and consumers in developing nations.

So, how to profit from this type of environment? Well, precious metals and commodities will continue to climb but will deliver diminishing returns given the current rate of run-up. Another more conservative option is to buy equity index funds when they are trading below NAV and just buy and hold. Don't even open the newspaper but just sit tight and wait for inflation to take effect.

The bottom line: The dollar's decline is both fundamentally and technically all but ensured. While brief rallies may delay the dollar's inevitable decline they do nothing to stem the vast forces moving against it.

India Defers Lifting Wheat and Rice Export Ban

2011-05-03T12:21:00.003-04:00

India, like most of Asia, is suffering from a prolonged bout of inflation. And not just inflation. But food and energy inflation. While Americans spend about 10% of their disposable incomes on food, the percentage is much higher in countries like India. Estimates vary but run anywhere from 33%-70% of incomes. In any event, it is a much larger figure than the developed world and America in particular.

This background context is important in understanding why Indian officials are still hesitant about lifting a more than a 3 year old ban on wheat and rice exports. They are understandably nervous about the potential impacts on social stability.

It is also likely that the Reserve Bank of India, the central bank, will act to raise interest rates to cool rising prices. Unfortunately, the source of much of the world's problems are not based domestically but come from abroad in the form of Washington DC's Federal Reserve. The Fed's insistence on maintaining low interest rates has resulted in an ocean of liquidity for Western fund managers to speculate on multiple asset classes. The original intentions were to stimulate lending among US borrowers. However, returns on asset classes such as commodity trades have proven to be far more lucrative and that's where the bulk of the funds have migrated. Of course, all trades carry an element of risk but ever since QE 2 was announced in late summer 2010, the returns on commodity trades have beat any loans that financial institutions could make to cash strapped US borrowers.

India Panel Defers Lifting Of Wheat, Rice Export Ban
An Indian ministerial panel deferred a decision on lifting a ban on wheat and rice exports as it wanted to first take stock of requirement under a proposed food security law to increase subsidized grain sales, a senior government official said.

The country is facing a dilemma as there is little space left to store grains in government warehouses. That had triggered speculation the government may soon allow limited exports of wheat and rice.

India's Farm Ministry had been pushing for some exports as procurement from a bumper wheat crop is underway, but food ministry officials have opposed the move, saying that it will need to keep all the stocks bought from farmers to meet the proposed food security law.

Last month, Farm Secretary P.K Basu said India can easily export 2.0 million tons each of wheat and rice because of good stocks and a likely bumper production this crop year through June.

India, the world's second-largest producer of wheat and rice, has maintained a ban on exports of the two staples for more than three years to curb inflation, although it has allowed limited shipments under diplomatic agreements.

The country is expecting a record foodgrain output of 235.9 million tons in 2010-11 because of favorable weather and higher plantings, up from 218.1 million tons last year.

As of April 1, India's rice and wheat stocks stood at 44.18 million tons, more than double the buffer requirement.

The food ministry official, who didn't want to be identified, told Dow Jones Newswires that the ministerial panel cleared a proposal to import edible oil for subsidized sales to the poor until Sept. 30.

The move will allow the world's top edible oil importer to continue supplying cheap cooking oil beyond the previous deadline of March 31 to millions of poor families. The food ministry had proposed to import 500,000 metric tons of edible oil through various state-run agencies on behalf of provincial governments.

India's state-run trading agencies have been importing edible oil regularly since July 2008 and selling them below cost for welfare programs. The federal government later reimburses the agencies for selling edible oil below cost.

The state-run agencies imported around 650,000 tons of edible oil in the last fiscal year that ended March 31.

India meets more than half of its total edible oil requirement of about 15 million tons through imports from Indonesia, Malaysia, Argentina and Brazil.

The ministerial panel also approved a proposal to supply around 120,000 metric tons of common-grade rice and 106,234 tons of wheat flour to Maldives from April 2011 until March 2014 to honor a diplomatic request, the official said.

The panel also approved a proposal to supply a total of 5.0 million tons of wheat and rice from federal stocks to poor families over six months starting June 1, a move that will help trim stocks at overflowing warehouses.

Source: CME News for Tomorrow

The Bottom Line: Indian officials are still nervous about inflationary outlooks and are acting to build up abundant food reserves. Ultra low US interest rates are contributing to a massive ocean of liquidity that is raising commodity prices around the globe.

Argentina Moves to Limit Foreign Speculators in the Agricultural Space

2011-04-28T00:52:00.002-04:00

A few posts ago I noted the trend by agriculture rich governments to limit foreign ownership by speculators of cropland. Here is the latest update from Argentina, the second largest producer of soybeans after the USA and an important source of cattle and wheat as well. Most moves of this nature are aimed not so much as the small investor but large foreign funds - including sovereign wealth funds - namely Chinese and Middle Eastern ownership.

Argentina Pres Sends Congress Bill Limiting Foreign Land Ownership
Argentine President Cristina Fernandez has sent a bill to Congress placing strict limits on the amount of farm and rural land that foreigners can purchase, throwing cold water on a wave of foreign buying of farmland in the agricultural powerhouse.

Under the proposed bill, foreigners will be limited to buying 1,000 hectares (2,500 acres) each and a nationwide survey will be conducted to ensure that no more than 20% of the country's total rural area is in the hands of foreigners, Fernandez announced.

Existing landholdings held by foreigners will not be affected, Fernandez said.

Source: CME News For Tomorrow

China's Cheap Vegetable Problem

2011-04-26T20:33:00.002-04:00

Followers of all things China related will not be surprised to know that it is suffering from major inflationary problems. However, readers may be surprised to know that China also has an abundant supply of food, namely cheap vegetables. So much supply that in fact, farmers are leaving their crops to rot in the fields.

China's Cheap Vegetables Problem
When China suffers inflation, food prices are always a significant part of the problem. But the conundrum China's leaders face with this latest round of inflation is somewhat bizarre: While the country's consumer price index is running at a near three-year high, vegetables are so cheap that tons and tons of them are being left to rot away in the fields.

Of course, vegetables are still expensive in the cities, and only in the cities, and that's exactly where the problem is. According to the official Xinhua News Agency (in Chinese), fat, juicy Chinese cabbages are selling at one yuan per 500 grams in city markets -- ten times the price the cabbage growers can fetch in the countryside.

Why, with urbanites paying such princely sums, are farmers leaving their cabbages on the ground? Because middlemen, transportation companies and the government itself are pocketing the bulk of the price differential.

Logistics-induced costs accounts for two thirds of the total cost for vegetables nationwide, Zhou Wangjun, vice director of the National Development and Reform Commission's price section, is quoted by Xinhua saying.

It turns out the problem isn't limited to produce. Referring to official statistics, Xinhua also said logistics-related costs constitute as much as 21.3% of China's gross domestic product, compared with just around 10% in developed countries. In a rather baffling example, Xinhua said it costs between 6 and 8 yuan to move one kilogram of goods via land transport from Shanghai to Guizhou, a province in the southwest, while it costs only 1.5 yuan to fly the same amount from Shanghai to New York.

According to estimates by Wang Tongsan (in Chinese), a researcher at the Chinese Academy of Social Sciences, 82% of the world's toll-charging highways are in China, with road tolls accounting for as much as 50%-70% of logistics costs nationwide.

In the current climate, the logistics squeeze has had dire effects on more than just urban grocery budgets. Earlier this month, according to a report in the China Economic Times (in Chinese), the recent plunge in vegetable prices triggered the decision of a farmer in Shandong province to end his own life.

Transport-related charges, some of which are a result of arbitrary decisions by local governments, also were at the heart of a trucker strike that gummed up Shanghai's large container handling ports last week. The strikes fizzled out yesterday as authorities pledged to cut some of the fees and offered new relief to the truckers.

Economic officials and central bankers in Beijing have repeatedly stressed the importance of managing inflation expectations in the country's fight against rising consumer prices, but the vegetable price dilemma is a stark reminder that taming the China's inflation tiger won't be so easy.

Source: CME News For Tomorrow

USDA Raises Food Inflation Outlook Again

2011-04-25T20:29:00.002-04:00

Fresh from raising its price outlook on the grains, the USDA has now expanded its inflationary view to include staples such as beef, pork, and even fresh vegetables. Unsurprisingly, some analysts believe the government is understating the scale and scope of food inflation. High prices on essentials such as food act as an implicit tax on consumer consumption in non-discretionary areas.

USDA Raises 2011 Beef, Pork, Vegetable Price Forecast
The U.S. government raised its forecast for retail prices of beef, pork and fresh vegetables, but left its overall food-inflation forecast for 2011 unchanged.

The overall food price-inflation forecast held steady at 3% to 4%, the U.S. Department of Agriculture said in its monthly analysis of the U.S. government's Consumer Price Index for food, which tracks retail prices of everything from milk to cooking oil and steak. But within the report, there are signs that inflationary pressures are approaching the high end of that range, thanks to higher energy costs and the 10-month-long rally in the price of grains.

Retail beef prices are forecast to jump 7% to 8% in 2011, up from a March forecast of 4.5% to 5.5%. The USDA also projected that retail pork prices will climb 6.5% to 7.5%, an increase of one-half percentage point from the prior month.

While several categories within the CPI showed higher inflation, those categories are weighted and weren't enough to push the overall food-inflation forecast beyond the 3% to 4% range.

Still, some private forecasters said retail food prices are climbing more sharply than the USDA is willing to forecast. Michael Swanson, an economist at banking giant Wells Fargo & Co., said Monday that he expects the government's CPI for food to climb 4.5% to 5.5% in 2011.

"There just isn't a single major food category where prices aren't climbing," he said.

Such a sharp acceleration in retail food prices would be a big change from last year, when the CPI for food rose just 0.8%, the mildest food-inflation rate in 48 years. Last year, many food manufacturers and supermarket chains choose to absorb their higher costs rather than attempt to pass them along to consumers worried by the stubbornly high unemployment rate.

For now, food retailers are passing through increased commodity costs, which "could temporarily boost profits across the value chain," Janney Capital Markets said in a note to clients. But ultimately inflation, coupled with consumers balking at higher prices, could pressure retailers' margins as the year progresses, the firm said.

Livestock prices have soared in recent months at the Chicago Mercantile Exchange, driven largely by sharply higher feed costs and expectations of shrinking animal supplies. Prices of cattle futures contracts hit an all-time high in early April, while lean hog futures hit a fresh record last week.

The U.S. cattle herd stands at a more-than-five-decade low, while the U.S. breeding herd for hogs is just above all-time lows.

Meanwhile, grain prices have rallied since last summer on strong demand and disappointing crops around the world that have depleted supplies.

Consumers of fresh produce are also feeling the sting. The USDA projected that prices for fresh vegetables will increase 4.5% to 5.5% this year, up from a prior forecast of 4.0% to 5.0%.

Lettuce, which has been affected by freezing weather in Mexico and Arizona, cost 27.3% more in March than it did a year ago, according to the USDA. Potato prices are up 12.1% during that period and tomatoes are up 10.6%.

The USDA also raised its projected price increase for fats and oils, increasing it to 6% to 7%, up one percentage point.

Source CME News for Tomorrow

Are Precious Metals Overbought? Backwardation, Contango, and their Place in Levered ETFs

2011-04-25T10:49:00.002-04:00

Are precious metals such as gold and silver overbought? In particular, silver's dramatic rise of over 25% in 10 trading days has given even the most bullish room for pause. Levered ETFs based on underlying gold and silver have risen even more dramatically and are currently trading in the mid-triple digits.

The key to determining mkt direction on the levered ETFs is determining whether or not the underlying is in contango or backwardation. This was the key to trading SKF, FAS, FAZ, and the other levered ETFs. It applies to both bull and bear etfs.

This is b/c no underlying - especially w/commodities - can ever offer a positive roll yield. Inverse etfs (aka the shorts) have a positive roll yield when the underlying is in contango. Bullish etfs on the other hand have a positive roll yield when the underlying is in backwardation.

Backwardation refers to a situation where the underlying's spot price is much more than the futures price. A perfect example is the commodities market now for grains (corn, wheat, soybeans). Contango refers to a situation where the future price of the underlying is more than the present. Perfect examples are Vix call options now and oil in 2009 when it was trading at $65/barrel.

A) Contango
Because the normal course of the underlying futures contract in a market in contango is to decline in price, an inverse fund composed of such contracts sells the contracts at the high price (going forward) and buys (closes) out later at the usually lower spot price.

This was the case of SKF, FXP, SRS and the other levered bear funds in late 2008-early 2009. Markets kept on closing consistently lower, week after week, month after month.

The opposite is true for bullish funds.

B) Backwardation

Because the normal course of the underlying futures contract in a market in backwardation is to increase in price, a bullish fund composed of such contracts sells the contracts at the high price (going forward) and buys (closes) out later at the (usually) lower price. But wait! I said usually. What if the underlying STILL remains in backwardation, month after month, expiration after expiration? The
underlying will continue to rise and in a levered etf it will take off like a rocket ship to the moon. This is why the silver 2x ETF, AGQ, is flying so high now.

As with any commodity, backwardation usually implies some shortage of physical supply. Not just a shortage. An extreme shortage.

C) Margin, Interest Rates, and CFTC Position Limits

Interest rates play a role too. When interest rates are low (like now) it becomes cheaper for funds to physically store and insure the metals.

Exchanges also periodically raise margin requirements when they think a commodity is getting too "hot". On the short side, we last saw this w/the inverse ETFs back in 2008-2009 during the SEC's notorious shorting ban (remember that? over 1000 stocks were deemed "financial companies"). We are seeing it this time on the bull side w/the CME raising margin requirements for oil, wheat, and corn. For precious metals, the CME has hiked margin requirements 4x already w/in the span of 1 year.

Nor is the USA alone in raising margin requirements. China also recently lifted margin on its own contracts in Shanghai by 3%.

Index funds and ETFs are the new, huge players on the commodities scene. Not hedgies and not investment banks. Everybody knows these massive funds' trading strategy: When a contract comes to expiration, they roll their contracts and buy long again (if bullish) or sell again (if bearish), regardless of what the price is. Under the
Dodd-Frank Act, position limits on derivatives are to be imposed by the CFTC.There have always been position limits in place. But they've not had either aggregate-month or all-month, or back-month limits. These ETFs and index funds are responsible for buying or selling (but more buying b/c bullish funds have more exposure and
capital) huge amounts and adding to volatility.

D) NAV

A fund's NAV, or net asset value, also plays a role in determining market direction. NAV is defined as the per-share dollar amount of the fund which is calculated by dividing the total value of all the securities in its portfolio, less any liabilities, by the number of fund shares outstanding. Levered ETFs frequently trade at a substantial premium or discount to their NAV value. Potential signs of overheating or cooling include double digit premiums.

E) Putting it all together

Sustained backwardation in any commodity is rare. It implies a physical shortage and thus a tremendous bull market. Silver is now in backwardation. Gold is leaning towards it but remains slightly neutral.

You can find out at a glance how slanted the backwardation or contango a commodity is by going to the CME's web site. This is silver's http://www.cmegroup.com/trading/metals/precious/silver.html

I do not associate backwardation with possible topping, I associate STEEP backwardation with possible topping. When I notice a steep backwardation curve I don't have to get short immediately (but will definitely pay close attention other technicals )AND will wait the curve to flatten out in the direction of contango. This is a contrarian signal.

F) Implications for the Dollar

The danger signs to watch out for is if gold slips into as strong backwardation as silver. If it does, then its all over for the $. There is basically uncharted territory below 71 (summer 2008 lows - also when oil peaked at $145/barrel). This was the low on a 10 year chart (2001-2011).

If you think that the US govt is going to default or go into hyperinflation, then keep any gold or silver you already own. But I'm getting ready to bet the other way. The US will not turn into Zimbabwe w/in the next few months and will act to tighten monetary policy.

G) Conclusion

Any signs that the market is reverting to contango (when futures are more expensive than the spot price), COMBINED W/bearish technicals, should be a yellow light for bulls to cash out and a potential sign for bears to begin easing into a short position.

Federal Reserve Official Outspoken on Inflationary Effects of Quantitative Easing

2011-04-16T20:01:00.004-04:00

There is at least one Fed official who can see the light beyond the shadowy gloom of the Federal Reserve's liquidity operations. Thomas Hoenig, FRB President of Kansas City, has been an outspoken dissident among the reigning policy chiefs. His position in the nation's farm belt has given him a much clearer view of the inflationary effects of the central bank's actions on food and fuel prices. On Friday afternoon, he noted with dismay the surging land price of farm land and agricultural commodities.

"We can extend the boom, and make the bust more difficult," Hoenig said at a panel discussion on food prices at Purdue University.

He said that interest rates can't stay near zero forever, and that investment in farmland is "gambling."

Hoenig, scheduled to give a lecture later Friday, also said that worries about inflation should extend beyond the core Consumer Price Index, which doesn't include food or energy.

"I think it is an error to look at just core inflation, except for a very short period of time," he said.

Source: http://www.nasdaq.com/aspx/stock-market-news-story.aspx?storyid=201104151205dowjonesdjonline000433&title=hoenigfed-stimulus-policies-exacerbate-ag-commodity-inflation

US Drought Affecting Farmers in the Southwest

2011-04-12T18:51:00.002-04:00

Wheat and cattle supplies are under threat from drought.

Fierce Drought Hurts Farmers In The Southwest
A scorching drought in much of the Southwest is hurting farmers across several states and potentially crimping supplies of crops and cattle.

In Texas, where the past six months has been the driest such period on record since 1967, more than half of the state is parched by extreme drought, according to the Drought Monitor, a compendium of government and academic estimates.

New Mexico, too, is drying out, with almost 75% of the state in a severe drought, the monitor shows. In Oklahoma, the period between January and March was the driest since 1921, including the 1930s Dust Bowl years, said the state's associate climatologist, Greg McManus.

Parts of the southern U.S. have battled drought on and off since 2006, but this year is shaping up to be particularly bad, because of an exceptionally dry winter and spring, when the region usually receives more rain.

The drought is hitting the Southwest at a time of rising commodity prices that have attracted the attention of policy makers in the U.S. and elsewhere. Because of the sizable agricultural industry in the Southwest, a decline in production could exacerbate an already tight supply situation.

Forecasts call for less-than-average rains in Texas and New Mexico in the next three months, and at least for the next month in Oklahoma, according to climatologists in those states. In response, at some of the country's most productive farms and ranches, farmers are destroying unsalvageable wheat crops and selling cows earlier than usual.

Bill Hyman, a cattle rancher in Gonzales County, Texas, about 70 miles south of Austin, said he auctioned off some of his animals earlier this year. With scant grass on the fields, he is feeding supplemental hay to the rest of his herd, but is keeping other expenses down to a minimum.

"We're not buying tractors; we're not buying equipment; we're not buying anything," said Mr. Hyman, who is also executive director of Texas' Independent Cattlemen's Association.

The U.S. Agriculture Department said 66% of wheat fields in Texas and 60% of those in Oklahoma were in poor to very poor condition as of Sunday. The two states accounted for 17% of the nation's production last year.

Much of the nation's winter wheat crop -- which is planted in the fall and harvested in early summer -- is grown on the Southern Plains. Because of the drought there, 36% of the U.S. winter wheat crop is in poor to very poor condition, compared to just 6% this time last year.

In a March report, the U.S. government said it expected farmers to devote 8% more acres to planting all types of wheat than last year. Wheat from other states could compensate for the lower-than-average yields in the south, but heavy rains in some areas, including North Dakota, have delayed the spring planting, said Kim Anderson, a crop marketing specialist with Oklahoma State University.

With wheat prices high, it's also possible that countries in the southern hemisphere such as Australia and Argentina will plant more wheat, he added.

Until recently, this growing season promised to be a profitable one for farmers, as the budding world economy raised demand for food.

For many farmers, it's not just the immediate harvest that is in danger. Terry McAlister, a farmer in Wichita County, Texas, 160 miles northwest of Dallas, said he decided not to spread fertilizer or prepare his fields for such summer crops as cotton and grain sorghum. "We're not going to be able to plant anything until we get rain," he said.

Craig Sanders, a farmer near Boise City in the Oklahoma panhandle, is more optimistic. Although he's expecting his wheat crop to start turning brown any day, he's going ahead with summer planting and hoping for rain.

"I've seen it happening in this country," he said. "It'll turn around and get wet and raise a hell of a crop."

The drought is also likely to further shrink herd sizes, which are already down some 500,000 beef cows from last year, according to USDA data.

"When it comes to enjoying a steak or hamburger, what happens with the drought in Texas eventually affects everybody," said David Anderson, a livestock economist at Texas AgriLife. The state is the biggest producer of beef in the country.

Source: CME News for Tomorrow

Australian Farmers Call For Restrictions on Foreign Investment

2011-04-12T18:46:00.002-04:00

Earlier last month, I had posted an article about Brazilian and Argentinian legislators contemplating potential restrictions on foreign investment in the agricultural sector. It's not just South Americans who are concerned about the hot inflow of money into the agricultural sector. Australia, a mining and agricultural powerhouse, is undergoing some of the same pressures.

Australian Farm Federation Questions Foreign Investment
Australia's National Farmers' Federation may seek restrictions on foreign ownership in the agricultural industry, its president Jock Laurie said.

Foreign investment is "certainly being questioned by the Australian community," said Laurie. "The industry in general and the Australian community in general though wants to see some sensible parameters put around who can invest and who can't invest in the industry," he said.

Laurie was testifying to the Senate Economics Committee, which is conducting an inquiry into the Foreign Acquisitions Amendment (Agricultural Land) Bill. The inquiry was established to review legislation proposed by independent senator Nick Xenophon and Greens senator Christine Milne to establish a national interest test on proposed foreign acquisitions of farm land. At present, the treasurer only has to assess purchases by foreigners of farm land valued at 231 million Australian dollars (US$241 million) or more.

Recent international investment into the Australian agricultural industry include, Singapore-based Wilmar International Ltd.'s A$1.84 billion purchase of CSR Ltd.'s Sucrogen sugar and renewable energy unit, which produces 40% of Australia's sugar output. U.S. agri-business giant Cargill Inc. is waiting for final regulatory approval for its purchase of the commodity management arm of AWB Ltd., the country's biggest wheat exporter, from Canada's Agrium Inc.

Rice farmers are considering a A$600 million offer for their processing and food company RiceGrowers Ltd., which trades as SunRice, from Spain's Ebro Foods SA.

Xenophon previously told the Senate that purchases of farm land had accelerated since the global food demand crunch in 2008, naming China, South Korea, Japan, India, Saudi Arabia and the Gulf states as buyers who have been most aggressive in their purchases. Laurie agreed that the rise in food prices in recent years had generated interest in Australian farm land.

"We need to make sure we maintain competition in the market," he said.

Source: CME News for Tomorrow

The Bernanke Put and Volatility Collapse: A Look at the Vix and 2 Year Swap Spread

2011-03-27T14:17:00.009-04:00

The slow melt up in US markets has been nothing short of astonishing. Global unrest that would have resulted in market sell-offs in the past have been shrugged off as non-events. Like a sailing ship depending on favorable winds, market bulls have continued pushing equity indices ever higher despite sighting multiple rocky shoals.

Political unrest in the MENA (Middle East North Africa) region, continuing EU insolvency, and higher commodity prices (particularly in fuel and food costs) have all been sighted and then dismissed as unimportant in the greater scheme of things. The force behind these winds has of course been Ben Bernanke's intervention on the markets, primarily in the Federal Reserve's Quantitative Easing programs (QE 2.0 announced last August) but also the continuing legacy effects in the distressed debt markets and cross currency swap programs w/other nations. The financial press has dubbed this combination of corollaries the "Bernanke Put" after the calming effect the Fed Chairman has imparted on market volatility.

The Bernanke Put's most dramatic effect has also been its most recent. The S&P 500 Vix which is a widely used indicator of volatility among buyers and sellers of US equity options saw its most dramatic decline in percentage terms on a weekly basis and its second biggest closing drop since the Japanese tsunami, earthquake, and nuclear meltdowns of March 16. The financial blog, Zerohedge, documents the event here while leaving the implications open to readers. Never mind that the effects of widespread nuclear radiation over an entire country are still unclear - the markets had already dismissed Japan as a non-factor going forward.

At this point, the technician in me feels the urge to add a few comments. I have pulled up my own daily chart of the Vix. Note the steep decline in the Stochastics which indicate a potentially oversold condition. Also noteworthy is the dramatic climb in the Standard Deviation. But pull back and examine the Vix on a longer horizon. While the Vix has experienced a dramatic fall, the charts indicate that there is further room for volatility to collapse.

My own thoughts are that volatility has collapsed too fast and too soon. Yet, I am also hedging my statements by indicating that there is further room to drop. On a historical basis using the benchmark of the past 4-5 years, the Vix has bottomed out at around the 15-16 level. Some readers may object that this time frame is relatively short. If so, they are welcome to expand their charts to as far back as 1995 (when the current Vix methodology was put in place).

But premiums on out of the money puts below the 15 level indicate that market participants don't really believe volatility can collapse much further. This is an implied floor. I think its safe to say that going long volatility (e.g. by buying future month calls) at those levels would be a relatively opportune bet on a risk/reward basis. Options premiums would have declined to sufficient levels to make such debit transactions relatively affordable. Note that this is pure speculation and not really a hedge. The options holder is still exposed to theta, or time decay. The Vix also signals a potentially overbought and oversold conditions among equity markets whenever it has advanced/declined by more than 25% on a weekly basis and more than 15-20% on a daily basis. Speculators can also play the reverse side by buying puts and/or selling calls once volatility has advanced by such levels.

But the S&P 500 Vix is not the only indicator of volatility. The CBOE (Chicago Board of Options Exchange) has been busy developing its proprietary Vix indicators for other volatile underlying assets such as (in no particular order) gold, oil, and now individual stocks. These instruments are all still relatively new and do not have the track record of the S&P 500 Vix so I do not readily follow them. Still I have mentioned them as an objective measure to be inclusive.

Another volatility indicator to follow is the 2 year swap spread (or 2YSS for short). The 2YSS measures the yield difference between 2 year interest rate swaps and 2 year Treasury notes. (Treasury notes are used as a benchmark for risk free rates b/c of the dollar's role as the only global reserve currency). The 2YSS is not as widely known among market followers as the Vix. However, it is a widely followed indicator among bond traders. Interested readers can obtain delayed data from Bloomberg's web site here here. Otherwise, real time streaming data requires access to a proprietary Bloomberg terminal.

Note that the 2YSS barely budged during the 2 week period of March 13-26. Thus, there was room for a fair bit of arbitrage trading between the equity, bond, and volatility markets. The last time it peaked was during late November/early December 2010 based on refinancing fears of the upcoming 2011 mortgage resets and fears of fiscal insolvency among US state and local governments as measured by municipal bond fund outflows. These fears were quickly quashed by additional Fed intervention and Congressional extension of additional tax cuts for another 2 years. Before this period, the 2YSS experienced its greatest volatility spike during the Greek budget Eurozone crisis of late May-June 2010 (which coincided interestingly enough w/the Flash Crash among US equities).

All this pondering on market volatility brings me to my final point. When will the Fed stop intervention? The short answer is: not anytime soon. But a more detailed explanation centers around speculation about the extension of Quantitative Easing 3.0 when the current operation is set to expire at the end of this June. Famed bond guru, Bill Gross, of PIMCO publicly stated that his fund had dumped its entire Treasury holdings in expectations of an end to Quantitative Easing.

Mr. Gross was not the only famed investor to publicly speculate on interest rate flows (readers more interested in Gross' thoughts can find out more here). Insurance companies and corporate CFOs are also rotating out of longer term US paper into shorter term maturities despite the paper losses they may take.

Sovereign holders of US debt such as Japan are believed to be in a position to temporarily stop or at least delay the purchase of additional US debt - especially in light of the massive amount of capital required to pay out insurance claims and reconstruction costs. A large part of the bill will be sponsored by the US and other wealthy nations but an already indebted Japan can ill afford to take on more debt. America's largest creditor, China, had already been on track to diversify its holdings of US debt. It is joined by oil exporters in the Middle East. The common unifying theme among these central banks? A push into gold and silver as reported by the Financial Times. Still, this should not be considered a carte blanche by China and Japan to eliminate US debt purchases. The basic public policies of both countries centers on ensuring cheap exports to maintain political and economic stability.
Eventually, the question will become not who is willing to buy US debt, but at what price and yield.

The Bottom Line: 1) Examine both the Vix and the 2YSS for arbitrage opportunities to go long or short among related risk assets and/or even volatility itself. 2) Quantitative easing is widely predicted to end by June 2011. Many market participants have already begin the process of rotating out of longer term US debt.

Japan Has Run Out of Bullets - The Implications of Joint Intervention

2011-03-26T20:17:00.003-04:00

In an earlier post, I had opined on whether it was time to buy Japanese securities after the immediate effects of the tsunami, earthquake, and nuclear meltdowns. At the time, I believed government intervention was possible - indeed even likely. However, I had not reckoned on the extent of intervention.

For years, analysts believed that the Japanese authorities had been rendered powerless from perpetual deflation as expressed in near zero percent interest rates. With rates already at record lows, there was no further room to cut and bond bears eagerly gathered around the short JGB (Japanese government bonds) trade. But instead of rates rising, the central bank was able to maintain rates at record lows for years and frustrate the shorts. The reasons behind this anamoly are two fold - one, most of the demand is domestic and two, regulatory barriers discourage foreign speculation. Indeed, Japanese corporations and elderly pensioners are sitting on an estimated cash hoard of at least ¥1,500 trillion ($18 trillion) of savings. But that was before the natural disasters of mid-March.

The worst two-day rout in 40 years caused a 6.2% drop in Nikkei share index, wiping £90 billion (roughly $145.45 billion) off stocks. The yen rally to a postwar high of
against the dollar of Y76.25 on March 16. In a desperate attempt to stabilize the markets, Japanese authorities printed an astounding amount of money. The numbers are mind boggling - 15 trillion yen ($183 billion) in liquidity during the first week and then an additional 13-15 trillion yen in the following week for a total of 28-30 trillion yen. The BOJ also intervened in the currency markets by selling over
Y2,000bn ($25bn) against the dollar on March 18. Other central banks followed in an extremely rare joint operation. Japan has essentially run out of bullets and is now borrowing cartridges from other nations.

While the exact amount of currency sold to weaken the yen is unclear what is clear are the implications behind the currency operations. In the past year, myself and other pundits had mused that the G20 was the new organization that had superceded the G7/8 in influence (Canada was the last member to be invited to join) after the financial crisis of 2008-2009. The interventions of mid-March proved that the G8 economies (USA, Great Britain, Canada, Italy, France, Germany, and Japan) continue to retain considerable power in world financial markets. While emerging markets such as China, Brazil, India, and (arguably) Russia are leading world growth, the centers of financial and political stability continue to emanate from the developed world.

The takeaway message here is that more - not less - government intervention is here to stay for the foreseeable future. Even though individual governments may have exhausted their own financial resources they can rely on tools such inter-bank swaps, forwards, and no interest loans (to name a few) from other nations. World governments have learned from their lessons in 2008 and 2009 that coordination is essential to bringing stability to financial markets. This has important implications for volatility and the Bernanke put in the coming months. But that is a topic for another time.

The Chinese Position on Libya

2011-03-18T14:17:00.005-04:00

It should come as no surprise to China watchers that the country has followed its historical pattern of abstaining from voting on critical UN resolutions. I speak of course of the current Libyan crisis and the UN vote on a "no fly zone." For the most part, this was a reasoned policy balanced on its lack of influence in certain volatile parts of the globe. What is the point after all, leaders reasoned, of interjecting themselves into a volatile part of the world that has historically captivated the West and three monotheistic faiths? For example, China has famously abstained on UN votes in nearly all Middle East centered resolutions such as both Gulf Wars against Iraq. However, in the present situation, that same line cannot be used.

The Chinese presence in Libya was substantial - comprising tens of thousands of workers in petroleum extraction, refining, transportation, logistics, and engineering. Additional workers were active in construction and mining. Indeed, China was Libya's primary customer for oil and natural gas exports, superseding even the EU as a customer base. In the immediate days and weeks of the initial protests, Beijing reacted swiftly and decisively by withdrawing nearly all of its staff in a massive evacuation operation to protect them against political violence. No expense was spared in round the clock airlifts, boats, rail lines, and buses to evacuate nearly 36,000 Chinese citizens. The official China news agency, Xinhua called it "a decisive success in China's largest-scale overseas evacuation since the birth of new China in 1949." The reaction was a shrewd one given the rebels' treatment of loyalists and government allies - namely the violent street justice executed against "African mercenaries" hired by the regime. In any event, the operation was a combined military and civilian effort that was swift, orderly, and above all effective in comparison to the chaotic and often ad hoc efforts of other nations.

Now that its citizens have been largely evacuated, China is now in the difficult position of balancing its strategic energy policies against its role as an emerging global power in international relations. The cozy relationship between the Politburo and Muamar Qadafi would surely come under intense scrutiny and perhaps even be jeopardized by any new regime. Several rebel spokesmen have already threatened to cut off ties w/Qadafi's business partners, a thinly veiled allusion to China. Although the exact amount of capital invested in Libya is not readily available to the public, Beijing has surely spent an enormous amount of money, time, and resources in cultivating a decades long working relationship with the country's leadership. This relationship in turn was founded in the shadow of numerous Western sanctions against Libya in the 1980s and 1990s for Libya's erratic actions such as sponsoring terrorist groups. Qadafi himself has seemed to turn on his erstwhile (unnamed) business partners and condemned them as cowards for abandoning him so quickly. In that light, the Chinese actions can be viewed as a poor attempt to ingratiate itself with both the West while preserving its investments in Libyan soil.

Or perhaps I am being too critical of Beijing. After China's initial opposition to the 2003 invasion of Iraq due in no small part to its substantial investments w/the Saddam Hussein regime in infrastructure, personnel, and logistics, Chinese firms were able to move back into the energy market by working w/the new US/British run government. Perhaps a similar event would occur again.

The successful model for a no fly zone can be found in the 1999 NATO campaign against Serbia. But even this is an inaccurate description. While the political talking heads intended to start by owning the airspace over Serbia, it quickly became apparent that they needed to escalate their selection of targets beyond mere air fields and radar sites. Strategic targets - including those of no military value - were quickly added. Bridges, roads, power stations, broadcasting towers, and government party buildings were all added to the list. Air strikes were eventually coordinated w/ground assaults by the separatist KLA (Kosovo Liberation Army). In a similar vein, any air campaign against Libya would become a de facto air arm of the rebel army. Add to that mix that even the rebels are unsure who is in charge and we have a recipe for political disaster akin to the situation in Iraq following the deposing of Saddam Hussein. So, perhaps the Chinese are right after all to be cautious. Still, the threat of prolonged air raids may be enough to move Qadafi to the bargaining table. Indeed, the no fly zone's political value may supersede that of any military one. It is even possible that a partitioning of the country may emerge - the rebel held east (full of oil) and the more urban west (not so full of oil).

Is US Farmland a Bubble?

2011-03-15T16:40:00.002-04:00

A few days ago I posted about rising agricultural land values in South America. Well, here is a look at the US market. While the US continues to suffer from prolonged deflationary effects in residential and office space, agricultural land values have soared. Is this a bubble too? Only time will tell. But the year long surge in corn, wheat, and soybeans - some by over 100% - means a correction has been in order for some time now.

Farmland Fund Expects Prices To Keep Soaring
Cheap farmland is hard to find.

Values in Iowa and other key agricultural states jumped 12% in 2010, the second-biggest increase in the past 30 years, according to the Federal Reserve Bank of Chicago.

Nationwide, prices have doubled during the past decade and climbed about 58% when adjusted for inflation, U.S. Department of Agriculture statistics show.

Still, Greyson Colvin is hunting for deals as managing partner of two farmland funds for his agriculture-focused investment firm Colvin & Co., which aims to acquire undervalued properties.

"The farmland market is certainly tighter than it's been over the last 12 months," Colvin acknowledged.

Colvin manages about 1,500 acres of farmland in South Dakota and Wisconsin, worth $7 million, in the Sather Agriculture LP fund, along with about 350 acres held in individual accounts. The fund, which was launched in 2009, had a return of 29.6% in 2010, up from 7.8% in 2009, according to the company, compared with 15.1% and 26.5%, respectively, for the S&P 500.

There are signs investors will continue to reap gains from the sector, Colvin said. He touted farmland as "the one element that you can't replace across the agricultural equation" and said rising global demand for meat will keep pressure on growers to increase production of grain, which is used to feed livestock.

The company targets land that produces corn and soybeans, the dominant crops in the fertile Midwest. Colvin and his brother-in-law, an associate in the company, inspect properties personally before making purchases to check their quality.

He scoffed at observers who warn soaring land values may form a bubble. Agricultural fundamentals are the best in decades, he argued, saying rising farm income and cash rental rates justify the appreciation in farmland.

"We really believe that farmland is actually underpricing commodities at this point in time," Colvin said.

Indeed, farmers have the potential to cash in big on coming harvests, as corn, soybean and wheat futures recently surged above 2 1/2-year highs on concerns about tight supplies. Domestic corn inventories are expected to plunge to a 15-year low by the end of the crop's marketing year on Aug. 31 due to strong demand and a disappointing harvest last fall.

If cash prices for corn, which is trading around $6.20 a bushel, remain above $5 at the end of the year, Colvin said farmland values should be up an additional 10% to 15%. The outlook for corn prices is uncertain because farmers are projected to harvest a record crop this fall to replenish supplies.

Source CME News for Tomorrow

Is is Time To Finally Short JGBs and Buy Equities?

2011-03-15T13:07:00.005-04:00

JGBs or Japanese government bonds, have been in a bull market for years. Near zero percent interest rates leave bonds with no more room to advance and is in large part, blamed for much of the financial malaise that has gripped Japan for the past generation.

In response to the devastating earthquake, tsunami, and multiple nuclear fallouts, the Japanese government has unleashed a massive spending program on an order that would make Ben Bernanke proud. Trillions of yen are being printed to address the short term liquidity crunch, pay for much needed repairs, and to support equity markets. (Note - While I do not intend to downplay the human toll of recent events, this is a blog dedicated to financial speculation and its ripple effects. It is possible to be both humane while still sticking to the original mission statement).

But even before the recent catastrophe Japanese public finances were in a dismal state. With public debt to gdp approaching 230% the JGB bond market had attracted the attention of bond vigilantes eager to short. In comparison, the US debt level is closer to 95%-100% (depending on which source you rely on).

While these bond bears had initially arrived in the early to mid 1990s following the dramatic Japanese market corrections and property bubble, most had moved on to greener pastures, unwilling and/or unable to fight the firepower of the Japanese central bank. Other bears switched to the increasingly lucrative forex trade where they sold the low yielding yen to buy higher interest bearing currencies like the Aussie, Real, and Kiwi.

In the intervening years, Japan continued to wallow through deflation. Its ranks of elderly grew while the number of young people shrank. These members of the "lost generation" became disaffected by societal changes beyond their control. Many became "otakus" or socially ignorant shut-ins whose only refuge was the Internet. The complete lack of job security for young workers who can only find temporary employment has made life difficult for new families and caused the birth rate to be cut in half (job openings are restricted to care for the ranks of middle aged and elderly that were promised a cradle to grave existence by prior managements). Society became more insular and engrossed in domestic affairs.

Nowhere was this demonstrated more dramatically than last year when China overtook Japan as the world's 2nd biggest economy. But even this event was noted with weary resignation by a population already accustomed to a diminished role on the global stage.

So, will the recent turn of events cause them to return? The short answer is possibly. But not right away.

Rising bond yields are correlated with rising equity markets. Or are they? In the months following the Kobe earthquake of 1995 the Nikkei continued to slide. The Topix bottomed out in June 1995 (Japan's largest index after the Nikkei, similar to the rivalry between the DJIA and the S&P 500). Even the Nikkei failed to regain its pre-2008 highs. Japan's government has traditionally been able to rely on domestic consumption to finance most of its needs. This is a generalization but foreigners find it difficult to engage the non-Japanese investor. Companies and families are now faced w/the prospect of liquidating their assets (including JGBs) to pay for much needed supplies like food, water, and housing - not to mention the enormous debris clearance and reconstruction efforts. Some bears are beginning to awaken from their hibernation, entranced by the prospects of JGBs achieving junk status in the near future.

But the BOJ has never intervened on a scale like this before. Additionally, the worst effects of persistent deflation seem to have been priced out. Indeed, the effects of deflation are so strong that JGB yields are STILL implying zero inflation despite oil >$120/barrel and staple food prices advancing over 150-200% in a year!

Risky Business in Asset(less) Lending

2011-03-15T12:49:00.004-04:00

Retail investors have been on a hunt for debt based yield ever since Bernanke announced QE 2.0 last year. However, most bargains had already been snapped up earlier in 2009 by savvy fund managers. Most of the best issues have already been priced out of the market as reflected in lower interest rates. This was a win win situation for both debtors and lenders as the former were able to refinance at a critical time while the latter was able to achieve impressive gains.

But as the year progressed, less financially sound companies began to seek similar sources of funding among investors. Those who missed the initial rally in high yield issues have piled onto riskier and riskier issues. The principal cases in point are the recent surge in covenant line loans, pik toggles (payment in kind), and other mezzanine based debt structurings.

These types of deals were blamed by some critics for being a harbinger of the financial crisis in 2006-2008. The higher returns being offered to investors are a reflection of the greater risk involved to junior creditors. The most worrying parts are loan provisions that allow a borrower company to default in the event of deteriorating finances or even natural disasters such as acts of god. Unlike senior note holders, junior creditors are usually left holding the proverbial bag in case of a default. They are usually unsecured, or lack collateral, in their underlying loans.

So, what are some warning signs of a potential default? Here is a short list - large borrowings to pay special dividends, large bonuses paid to management, poor cash flow, goodwill comprising an unexpectedly large part of the balance sheet, and potential legal suits.

http://www.ft.com/cms/s/0/9f7c528c-4da3-11e0-85e4-00144feab49a.html

The German Success Story

2011-03-05T16:22:00.001-05:00

Great article from Time Magazine about how Germany is becoming the success story of the EU. Exports have driven much of the country's growth since the doldrums of post-reunification.

http://www.time.com/time/magazine/article/0,9171,2053595,00.html

Chinese Farmland Continues to Experience Dry Conditions

2011-03-02T20:00:00.004-05:00

Some interesting news coming out of China. Of particular concern is the wheat crop. 2011's wheat harvest is dependent to a great degree on Chinese output. The problem is compounded by some local governments' insistence on re-routing water tables for industrial use. Winter wheat in particular is very water intensive.

Most Of China's Cultivated Farmland Lacks Irrigation -Official
More than half of China's cultivated farmlands are dependent solely on weather conditions for water, with only 49% served by effective irrigation, a senior Ministry of Agriculture official said in an essay on an academic website.

The government targets spending of CNY4 trillion ($608 billion) over the next decade on water conservation infrastructure projects. It is redirecting $12 billion this year from property tax revenues to irrigation projects and making water conservation the centerpiece of its 2011 agriculture policy.

Zhang Hongyu, the ministry's supervisor of agricultural policy, said on the Chinese Academy of Social Sciences Rural Development Institute website Tuesday that "irrigation is the weakest link in China's agricultural production infrastructure."

Two-thirds of China's farmlands are affected by drought, steep slopes, poor soil, salinity and other factors, he said.

In China, efficient water use through irrigation is just 60% that of developed economies, Zhang said in the essay, without elaborating.

In his essay, which was first published in the Communist Party's People's Daily newspaper, Zhang also called for the government to redirect industrial investments to the agriculture sector to "release the potential of rural consumption."

"The need to expand domestic demand is a basic necessity of improving agricultural infrastructure," he wrote.

Even as rural incomes have risen on the tide of surging agriculture commodity prices, China last year recorded its widest rural-urban income gap since 1978.

Source - CME News for Tomorrow

Argentinian Land Bubble?

2011-03-01T19:55:00.005-05:00

Longtime readers will know that I have long favored South America as an investment destination for agricultural products. Interest in all things agricultural has only grown with the advent of high food prices.

Type in buy farmland in Argentina on Google and you will face tens of thousands of hits. Most of the results are of dubious value and years old. However, I received a story today from a credible source that is pertinent.

Argentina Should Limit Foreigners' Farmland Purchases - Minister

Pressure is building in Argentina to limit the amount of land that foreigners can buy as record prices for grain and derivative products fuel concerns that deep-pocketed overseas investors might end up controlling a significant percentage of the country's farmland.

Last year, congressmen from a across Argentina's political spectrum sponsored about 12 different bills that would have put limits on foreign land ownership. While those bills are stalled in the agriculture commission of Argentina's lower house, the administration of President Cristina Fernandez looks set to weigh in on the issue.

"[Fernandez] believes that the legislature needs to debate the protection of the country's primary non-renewable strategic resource--the land," Agriculture Minister Julian Dominguez said in a speech on Sunday.

The land "has to stay in Argentine hands," Dominguez said.

Agriculture exports were largely responsible for Argentina's whopping $12.06 billion trade surplus last year, while taxes on farm exports accounted for a significant percentage of the federal government's tax revenue. Argentina is the world leader in soymeal and soyoil exports, ranks No. 2 in corn exports, and third in soybeans.

As global commodity prices soar, investors have increasingly looked to the fertile farmlands of Argentina and Brazil for investment opportunities.

That has helped fuel surging land prices in recent years. At the end of 2010, prime farmland in Argentina's Buenos Aires Province was selling for $15,000 a hectare (2.47 acres), according to local daily La Nacion. That is about double the price in 2007 and over five times prices in 2002 when the country was in the midst of an economic crisis (emphasis my own).

Argentina's northern neighbor, Brazil, has already taken steps to protect its national sovereignty over farmland. Last year, Brazil's former President Luiz Inacio Lula da Silva slapped limits on foreign ownership.

Land purchases involving a foreign investor or a local company that is majority owned by foreigners are now reviewed on a case by case basis. Certain limits will apply depending on the geographic area of the purchase.

A similar law is needed in Argentina, where about 7%, or 20 million hectares, of the country's productive farmland is in the hands of foreigners already, said Omar Principe, who heads the land commission at the Argentine Agrarian Federation. The association, know as the FAA, is one of the country's leading farm groups and represents small-scale farmers.

Source: CME News for Tomorrow

Equity Markets Tends To Rise in March

2011-03-01T17:17:00.002-05:00

I suppose I would be remiss if I did not take on the bulls' case. Well, here is an interesting note. The S&P 500 as represented by the SPY etf tends to rise in March. See attached chart. I am unsure for the reasons behind the rise and welcome thoughts.

A closer look at the shorter term charts and other market indicators is warranted before making a decision.

Update - Volatility Where Art Thou?

2011-03-01T15:34:00.005-05:00

Wow. I have not posted in a long time. I have been pursuing career development (like opening a law practice) in other areas and relegated blogging more or less to a hobby. To say the world has changed a lot since my last post is an understatement. Instead of giving a detailed chronological account of the last few months, I will jump right in and address the current event topics.

The markets have been on a bullish tear since Bernanke made his announcements of Quantitative Easing in late summer/early fall 2010. Since that time, the bulls have been seemingly undeterred by any bearish news. Even the collapse of two Middle Eastern dictators has not done much to stall their advance. However, there are multiple storm clouds on the horizon that would give even the most ardent among the herd a reason to head for shelter.

I see 2 problems looming, Stagflation and European defaults. Neither of these are new but the context in which they are being presented is changing rapidly.

Stagflation
Stagflation is defined as a combination of weak economic growth and high inflation. It is the one threat that has the potential to impede further progress in equities and other risk trades. After all, the recovery trade is more or less done at this point w/most companies having borrowed to buy back their shares (which is my own belief behind the market's advance). While inflation remains relatively low in the West, it is offset by continuing weak labor markets. Instead, inflation is strongest in emerging markets where food and fuel comprise a larger percentage of residents' budgets.

The fundamentals of higher food prices are linked to dietary progressions up the calorie chain for more expensive items. People used to eating rice and lentils have become hungry for chicken and beef. These added demand constraints on farmers and land use has been further exacerbated by volcanic activity in Kamchatka, Russia and colder weather patterns in the Pacific Ocean. Kamchatka is a remote province in the Russian Far East most famous for its large population of bears and elk. But the same geography that is responsible for its geographic isolation is also responsible for a recent spurt in eruptions that have sent hundreds of tons of soot and ash into the atmosphere. La Nina is a reference to the cooler waters in the southern Pacific Ocean that generally lead to drier weather in North and South America.

As any decent farmer knows, the world turns in cycles. (See some of my past posts on El Nino for example) Most of the seasons can be predicted with a great deal of accuracy. But these additional wild card factors are causing substantial changes in heretofore unforseen ways. The changes have resulted in supply constraints that have sent agricultural prices skyrocketing.

European Defaults

Private creditors are not exactly lining up to buy peripheral EU debt. They have their reasons. A case in point is the recent elections in Ireland that saw the outgoing party, Fiana Fail, lose the most within 3 generations. Irish voters were enraged beyond measure about the party that got them into the current mess and wanted to turn them into slaves to foreign creditors. So, why does an election in a country with a population a tiny fraction of the total EU? EU ministers have been promising that all debts will be repaid. Unfortunately Irish voters basically said NO to that idea with a resounding voice. The new govt is likely to push for
a restructuring - a default in all but name. And when that happens the other PIIGS will also want the same thing. What do you think will happen to the markets when a wave of defaults on that scale occurs?

VIX

Ok. Enough fundamentals. Let's talk technicals. After all that's the title of this post. For the purposes of measuring volatility we will look at the S&P 500 Vix (volatility options index). I like the vix because it is about as pure a mathematical indicator as you can get. It has been alternately called the fear index b/c when the vix spikes, it indicates nervousness among options buyers on the S&P 500 stock options prices.

So, how To Protect Against Volatility?

I have put up several charts of the vix which indicate a potential spike in volatility over the next few months. Note the ATR (average true range) and standard deviation indicators. Like all options, vix options pricing reflects market sentiment by the sellers for future months. Outright buying vix options (in this case calls) 3,4,5 months in the future seems feasible at first until you consider that the only way to make a profit on those is by having the rate of change accelerate dramatically (preferably in the near term). To some extent this is true of any options buyer but the vix is different b/c the underlying values change for every month. In turn this is due to reversion to the mean as measured by standard deviation - which is more volatile by far than the vast majority of stocks or commodities.

The vix also spends most of its time in contango - a term used to describe the larger premiums demanded for far off months than compared to near month contracts.(Vix futures can be priced for backwardation but this happens less often - usually when the vix is already flying next to black swans -look no further than the September 2008-March 2009). The reason for this can be readily explained by looking at the vix over a long period of time. While the vix can and does readily revert to the mean, it can spike significantly in the short term and even stay there for protracted periods of time. The higher priced premiums are the result of options sellers demanding suitable compensation for taking on that level of risk.

So, what to do as a trader or even a hedger looking to protect against a fat tail event? In (relatively) low volatility times, debit (put) spreads on index etfs or leading stocks seem to be the way to go. There is limited risk but limited upside (of course the upside can still be considerable). Premium selling strategies are not worth it with low volatility. Of course, one can always buy calls or puts (well in this case puts if you favor a sustained market correction). You still have to be right with both trades (debit spreads and straight options buying) but at least volatility is favoring the options buyers.

The Debts of the Spenders: The Stock Bulls Do Have a Case. Kind Of.

2010-08-05T15:47:00.002-04:00

The stock bulls have a fair value case. I know its not trendy to talk fundamentals anymore but bear with me. With interest rates so low, the P/E values don't look so bloated anymore.

If interest rates are double digits, the present value of a dollar that you're going to receive in the future from an investment is not nearly as high as the present value of a dollar if rates are 4% (which happens to be the rate of a 30 year treasury). In other words, a dollar of future profit becomes that much more valuable.

There has also been much talk about Bernanke restarting the bond purchase program again. This is synonymous with steady low rates.

And many companies are sitting on cash hoards. That means they wil either have to invest in plant/equipment, labor (hah!), or start giving out bigger dividends.

http://www.cfo.com/article.cfm/14508819/c_14511422?f=home_todayinfinance

In fact, with bond yields so low and some asset classes like mortgage securities trading above par, then it seems buying a bunch of blue chip stocks that yield consistent divvies is the way to go. Just stuff them in your IRA and wait for capital appreciation. Few financial advisors will tell you this because they can't make any commissions off this strategy.

I also urge readers to look at this article for some historical context. Note the year it was published:

http://www.safehaven.com/article/7721/interest-rates-and-market-valuation
*Credit goes to Kauneongal for the IRA strategy.

The Debts of the Lenders: China on the Soapbox Again About US Treasuries

2010-08-03T10:49:00.002-04:00

More harsh rhetoric about US fiscal profligacy. Chinese buyers, represented mostly by the state, are growing increasingly vocal in their criticism for the US to follow a European style austerity plan. . . . or else.

“I do not think U.S. Treasuries are safe in the medium-and long-run,” Yu, a
member of the state-backed Chinese Academy of Social Sciences, wrote yesterday
in an e-mailed response to questions. China is unable to sell the securities in
a “big way” and a “scary trajectory” of budget deficits and a growing supply of
U.S. dollars put their value at risk, he said.

“China has to depend more on demand and supply in the foreign exchange
market for the determination of the yuan exchange rate,” Yu wrote. “Only God
knows how much value that China has stored in the U.S. government securities
will be left in the future when China needs to run down its reserves.”

“The U.S. government has strong incentives to reduce its real burden of
debt through inflation and dollar devaluation,” he said. “Whichever way it is,
the yuan-recorded market value of Treasuries will fall, causing huge capital
losses to China’s central bank.”

http://www.businessweek.com/news/2010-08-03/treasuries-lack-safety-liquidity-for-china-yu-says.html

The Debts of the Lenders: China's Silk Road to Latin America

2010-08-01T22:25:00.002-04:00

Great article from Bloomberg.

“The potential for inter-emerging market trade is ginormous,” said Jim
O’Neill, chief economist at Goldman Sachs Group Inc. in London, who coined
the term BRIC in 2001 to describe the rising role of Brazil, Russia, India and
China. “That makes it quite difficult to see how you get a sustained global
recession because of what’s going on in the west.”

http://www.bloomberg.com/news/2010-08-01/new-silk-road-built-by-china-binds-asia-to-latin-america-with-global-trade.html

The Debts of the Spenders: The Dodd-Frank Wall Street Reform and Consumer Protection Act (“WSRCPA”)

2010-07-24T09:36:00.002-04:00

Just a quick overview of the recent US financial reform laws. The changes are sweeping and this is not meant in any way to be comprehensive. Updates will be posted as changes are made.

The law is formally known as the Dodd-Frank Wall Street Reform and Consumer Protection Act (“WSRCPA”). Readers interested in the Too Big To Fail aspect should focus on Title 2 (see below).

The Banking Lobbyists' perspective:

http://www.aba.com/RegReform/default.htm

For a timeline of when the rules will be effective:

http://www.aba.com/aba/documents/RegReform/EffectiveDatesChart.pdf

The other ABA (American Bar Association - which is not to be confused with the American Bankers Association) also has its own views and is having several upcoming programs:

http://www.abanet.org/cle/programs/t10nfr1.html

One of the biggest changes is the introduction of the OLA, or Orderly Liquidation Authority, which REPLACES Bankruptcy Court under the auspices of the FDIC (the OLA is part of the FDIC) under Title 2. The OLA will be responsible for probating the "living wills" of too big to fail institutions. All legal challenges will fall under the APA (Administrative Procedure Act) which governs nearly all federal agencies - (you can be sure there will be plenty of legal challenges being filed in the coming months).

Also, many of the aspects covered in the Cadwalader (a major white shoe law firm) legal memo made it to the final law.

http://www.cadwalader.com/assets/client_friend/072010_DF2.pdf

http://www.cadwalader.com/assets/client_friend/072010_DF1.pdf

The Debts of the Lenders: How Much Further Can the Yen Rally?

2010-07-17T11:35:00.003-04:00

The Yen has been on a wild tear in recent days, notching impressive gains against the dollar on safe haven flows. Additionally new laws on Japanese leverage limits are imposing margin calls on speculators.

The introduction of leverage caps on foreign exchange margin trading in Japan in the coming month is likely to place pressure on the Australian dollar/yen cross rate, according to research by the Royal Bank of Canada.

The Japanese regulator will impose a cap of 50 times leverage on collateral for margin trading at the start of August to curb currency speculation by retail investors. The cap will be further lowered to 25 times from August 2011.

Source:

http://www.risk.net/asia-risk/news/1723009/rbc-japanese-limits-margin-trading-weigh-aussie-yen-cross-august

So, where does support and resistance lie? There is still further room for a rally. Up to 85 or 118 on the corresponding $XJY index which closely matches the CME and Globex price quotes. This represents the currency's 14 year low which was reached late last year.

At these levels, it is likely that the BOJ will take steps to intervene. The bank has already released official statements that they are watching the situation closely.

July 15 (Reuters) - Bank of Japan Governor Masaaki Shirakawa said on Thursday he was continuing to watch currency and stock price moves carefully.
"Yen rises hurt exports short-term while stock price falls have a negative impact on capex and consumer spending," Shirakawa told a news conference.
"While the yen's rise and stock price falls may affect Japan's economy I expect it to remain on a recovery trend."

Source: http://www.reuters.com/article/idUSTKU10614120100715

The Debts of the Spenders: Chinese Rating Agency Downgrades USA

2010-07-13T11:30:00.001-04:00

Along came a Beijing-based rating agency--Dagong International Credit Rating Co. Its first order of business is to downgrade sovereign debt ratings on some major Western nations, while slamming its Western counterparts.
"The reason for the global financial crisis and debt crisis in Europe is that the current international credit rating system does not correctly reveal the debtor's repayment ability."
Dubbed as the world’s first “non-Western” sovereign credit rating agency, in its debut international report, Dagone (means Big Justice in Chinese) downshifted the US to AA with a negative outlook, while UK and France were given AA-; Belgium, Spain, Italy with A-.

Source:

http://dianchu.blogspot.com/

Correction on Prior Post

2010-07-07T15:03:00.003-04:00

*Credit: Tjemme

I confused yield chasing with the effects of inverted yield curves.

The economics textbook explanation was a bit dry so I went and looked at a multi-year chart of the 30 year bond instead. If you go back to the early 1980s, the 30 year yield was hovering around 10% and hit a high of 15% in September 1981. Then it went progressively lower past 1984.

http://finance.yahoo.com/echarts?s=%5ETYX

So, those investors who bought at double digit yields reasoned that rates were going even lower in the future. They bet that was their last chance to lock in rates before the bottom fell out. Past 1984, they turned out to be right.

So far, the current scenario does not look like a repeat of the early 1980s. Right now, the Fed is intent on keeping low rates for a while longer instead of tightening. This is not the correct environment for an inverted yield curve.

The 'move up the curve' does not put upward pressure on short-term rates. Chasing yield only in this way only works when long-term yields are higher. Chasing yield effect works by slowing pushing down the yieldcurve starting from the beginning. Inversion contradicts chasing yield.

The Debts of the Spenders: The Dangers of an Inverted US Yield Curve

2010-07-07T10:54:00.002-04:00

Economists and traders believe that inverted yield curves are a sign of impending recession. It is possible but rare for the longer end to have lower yield than the front end of the curve. Potential causes include direct US Federal Reserve intervention, Chinese and Japanese sovereign buying, and finally yield chasing by funds. It is this last point that I want to bring my attention towards.

In theory, lower yields are supposed to push businesses towards renewed economic activity by lowering their borrowing costs. The private sector is then able to finance expenses like plant and equipment, back office updates, and labor costs more cheaply than if rates were higher.

Unfortunately, reality is a different story. Generally, the US business sector remains leery of renewed spending and has instead slashed costs to the bone by enacting their own fiscal austerity measures - firing unnecessary workers, gutting expense accounts, and deliberately slowing payment to creditors while pushing for timelier payments towards their own customers. This is a normal reaction to a recession.

Instead of pushing business borrowing up, the current easy monetary stance is pushing speculators to borrow money at lower short-term interest rates and invest it in higher return assets - either in equities (which is Bill Gross' latest argument) or higher yielding debt (such as private sector high yield, emerging market bonds, or Greek government debt). However, because the buying mandates of many institutional funds require managers to buy investment grade only, they will inevitably turn towards longer dated US government debt. This effectively puts upward pressure on short-term rates and downward pressure on long-term rates.

The end results will not be pretty when rates do rise. Whoever bought all this high yield debt will lose a lot of money . . . even comparatively speaking if they were to hold until maturity.

My final cause of concern is that Bernanke himself believes that inverted yield curves are nothing to worry about. Bernanke has been wrong about a lot of things so whenever he's championing a particular idea I tend to be suspicious about it. When Bernanke made this speech it was in 2006 - then the height of the credit bubble. Well, we both know what happened in the 4 years since then.

http://www.federalreserve.gov/newsevents/speech/bernanke20060320a.htm

The Debts of the Spenders: European Stress Tests A Joke But Fiscal Austerity Measures Are Working

2010-07-07T10:52:00.001-04:00

Apparently, EU ministers believe that CDS traders and European bond desks are stupid. Their stress tests do not account for any sort of default scenario. This is ironic considering how a potential Greek default has led to a freeze on interbank lending among the PIIGS. Besides the more obvious triggers of outright bankruptcy and delays, please also note that the legal language of most CDS contracts states that a debt restructuring CAN lead to a default. Such catalysts are referred to dryly by lawyers as "credit events" and WILL drive the CDS spreads wider.

Of course, when the market tries to act efficiently traders will somehow be blamed for lower prices and higher yields.

FRANKFURT (MNI) – Planned stress tests for European banks will cover their resistance to a crisis in the market for European sovereign debt, but not the scenario of a default of a Eurozone state since the EU would not allow such an occurrence, a German newspaper reported Wednesday.

http://www.forexlive.com/117451/all/eu-bank-stress-tests-to-cover-debt-crisisnot-sov-defltpress

But not everything is bad in Europe - for one thing, the British, Greeks, and Germans seem able to pass an austerity budget - a fact that forex markets have noted with optimism by driving up the value of the GBP and Euro in recent days. If only the US could learn that lesson. Unfortunately, our politicians' bad behavior is being subsidized by the Chinese, who continue to buy treasuries blindly.

While default risk remains virtually non-existent at the federal level, the same cannot be said of state and local finances. The US muni market which consists of state and municipal finance is facing severe funding problems.

"Commercial lenders added more than $84 billion to their holdings since 2003, according to the Federal Reserve, pushing total investments to $216.2 billion at the end of the first quarter. Bank regulators and ratings companies are ramping up scrutiny of banks most at risk of being forced to raise more capital should debt prices slide.

“There is a huge untold problem here,” said Walter J. Mix III, a former commissioner of the California Department of Financial Institutions who closed 30 banks during the last banking crisis in the 1990s. “The economics lead to the conclusion that there will be downward pressure on these bonds.”

Default speculation and a move by investors to the safest securities drove municipal bond yields to a 13-month high relative to U.S. Treasuries in the first half of the year. Now, the Federal Deposit Insurance Corp. has asked analysts to look into the issue, according to spokeswoman Michele Heller.

U.S. states are likely to face $140 billion in cumulative budget gaps in the coming year, according to the Center on Budget and Policy Priorities. Last year, 187 tax-exempt issuers defaulted on $6.4 billion of securities, the most since 1992, according to data from Distressed Debt Securities in Miami Lakes, Florida.

“It’s a market where it’s clear that the underlying fundamentals are lousy,” said Michael Aronstein, chief investment strategist at Oscar Gruss & Son Inc., a New York- based brokerage. “People can say fundamentals don’t matter but I’ve been doing this for 32 years. They do.”

http://www.businessweek.com/news/2010-07-06/u-s-banks-risk-untold-problem-as-muni-debt-swells.html

The Debts of the Spenders: PIMCO Blasts Fannie and Freddie for MBS Manipulation

2010-06-29T09:42:00.003-04:00

And here I thought PIMCO would be happy with these high prices. . . Oh wait, they sold most of their MBS months ago. For more irony, compare this story against the backdrop of strategic home defaults where 1 in 5 or 20% of homeowners (err...isn't that the wrong term?) choose to default on their mortgages even when they have the funds to meet payments.

"The 30-year 5.50 percent coupons are insanely expensive," Scott Simon, head of mortgage and asset-backed securities at Pimco, manager of the world's biggest fixed-income fund, said in an interview with Reuters. "If they (Fannie and Freddie) could make the most money selling agency MBS, they should."
The global financial turmoil has benefited not only U.S. Treasury securities, but also agency MBS as foreign and domestic buyers have sought the relatively safe-haven investments.
But Simon also said prices on the MBS are too rich for his taste.
"Even if this coupon cheapened a full point, I would still not like them and we are not even close to levels where I would consider buying them," he said.
"We have to assume that somebody must have been telling them not to sell," Simon said. "They are not supposed to be running a business where they lose money holding on to their positions."

http://www.reuters.com/article/idUSN284186220100628

The Debts of the Lenders: Bill Gross Claims Stocks Will Outperform Bonds Within the Next Few Years

2010-06-24T21:09:00.006-04:00

Continuing on the bond vein, Bill Gross of the famed PIMCO bond fund, came out today and said that now is the time to go long equities (when has he ever said that?). His argument is that the bond rally of 2008-2010 is at its peak and we'll see bonds lose their value as interest rates slowly climb.

I think he's got the right idea about the eventual return on assets but I have my doubts about his timing - especially after the Fed confirmed low rates again at this week's meeting. Continuing distress in European and US credit markets means that the 10 year yield may see 290 or lower. (The last time that occurred was in the dark days of Fall 2008 and early spring 2009).

Note - the right chart is of the 10 year yield which is inverse to price. The left chart is of the US corporate bond returns from July 2009 to the present.

If you are curious to know more information about bond returns click here to sort bonds by total return, yield, price, and volume.

http://www.investmentnews.com/article/20100624/FREE/100629954

The king of bonds is now talking up stocks as a better long-term investment. He says that as U.S. Treasury returns fall, investors will have to take more risk with high-yield bonds, equities and, eventually, real estate.

“If you're talking about the next 10, 15, 20 years, there's certainly the recognition that assets will grow faster in those categories,” he says. “Over the long term, stocks return more than bonds when appropriately priced at the beginning of an investment period.”

The Debts of the Lenders: Mortgage Bonds Rally On Irony

2010-06-24T09:33:00.003-04:00

Several months after Bernanke ended his purchase of MBS securities, the market is seeing even loftier heights. The reason?

Speculators are betting that since the housing market remains weak so too will mortgage refinancings. (Lending standards are a lot tougher and so are the supply of mortgage brokers). Combine that with a limited supply of bonds and you have a recipe for bonds trading well above par.

Even PIMCO, the fixed income giant that spearheaded the initial MBS purchase drive in late 2008/early 2009 was stunned by the rally in prices.

The average price of $5.2 trillion of bonds guaranteed by government-supported Fannie Mae and Freddie Mac or federal agency Ginnie Mae climbed to 106.3 cents on the dollar yesterday, according to Bank of America Merrill Lynch’s Mortgage Master Index. That’s up from 104.2 cents on March 31, when the Federal Reserve ended its program purchasing $1.25 trillion of the debt.

“It’s gotten insane,” said Scott Simon, the head of mortgage-backed securities at Newport Beach, California-based Pacific Investment Management Co., manager of the world’s biggest bond fund. “This is rarefied air.”

So, what could cause the rally to end? If the government were to figure out a way to force lenders to re-finance (profitably).

http://noir.bloomberg.com/apps/news?pid=20601087&sid=aC0TeonWOPiI&pos=6

Here is some historical perspective:

http://debtsofanation.blogspot.com/2009/09/debts-of-spenders-putting-government_24.html

The Debts of the Spenders: Greece Attracts Chinese Investment

2010-06-15T15:20:00.002-04:00

Earlier this year, China had rebuffed efforts by the Greek government to invest (e.g.bailout its moribund banking sector). But apparently all that has changed now. China is apparently realizing its responsibility to the rest of the world as a key pillar of economic stability - even if such efforts may lead to months or even years of initial losses.

A delegation led by Zhang Dejiang, a Chinese vice-premier, will seal a series
of agreements on Tuesday with local companies, a Greek government official
said.
“These concern maritime affairs, telecoms and a project to renovate a
landmark tower building in Athens’ port of Piraeus,” the official said.
Deals for joint ventures, charter agreements and shipbuilding deals worth
€500m ($615m) with Greek shipping companies will also be signed.
China’s state shipping company Cosco already controls a container terminal at Piraeus under a €3.4bn long-term concession deal. Cosco is expected to make a joint bid later this year with Greece’s state ports company to create a €150m-€200m logistics hub near Athens to distribute goods for China in the Balkans.

http://www.ft.com/cms/s/0/8e736a84-77d9-11df-82c3-00144feabdc0.html

The Debts of the Spenders: The Continuing Greek Tragedy

2010-06-11T11:10:00.006-04:00

Here's the problem. Greece cannot devalue its currency.

Since the beginning of the euro, Germany has become some 30% more productive than Greece. Very roughly, that means it cost 30% more to produce the same amount of goods.

Labor costs must fall by a lot. And not by just 10 or 15%. But if labor costs drop (deflation) then that means that taxes also drop. The government takes in less and GDP drops.

It looks like Greece will have to eventually leave the Euro someday. Just imagine the legal bills involved because all the contracts are in Euros. That will be a great day for the lawyers.

So in the meantime, banks that have pledged to refinance (e.g. are holding Greek government bonds) are stuck in a game of Prisoner's Dilemma where each side is waiting for the other to engage in mutually harmful retaliation.

(Prisoner's Dilemma is a popular Economics/Political Science stratagem taught to university students. It is a study of BEHAVIORAL economics rather than RATIONAL economics and was popularized during the Cold War to study the effects of Mutually Assured Destruction). The emphasis on behavioral economics is not accidental - studies have repeatedly shown that actors rarely act in their best, or rational, interest.

Here is how one analyst describes the current situation:

“From an individual bank’s perspective, it would be great to get rid of the sovereign debt,” Hoffmann-Becking said by telephone. “However, if everybody did it you’d have a rapid collapse of the government bond market and then you’d have the default. And in the default, the fact that you have no sovereign debt actually doesn’t help you at all.”

http://www.bloomberg.com/apps/news?pid=20601010&sid=aVTX9yKZzdJ4

The Debts of the World: Where Do We Grow From Here? Part II

2010-06-11T11:08:00.002-04:00

A history of US federal interventions (bailouts):

A) Late 1970s - US bails out municipal bonds by guaranteeing state and some local (NYC) bonds.

B) Early- Mid 1980s - US bails out third world nations and Latin America via Brady Bonds.

C) 1989 - US bails out commercial real estate via the Resolution Trust Corporation

D) 1997-1998 - US bails out emerging markets in Asia via IMF.

E) 2008 - US bails out investment banks (except Lehman Bros) via TARP and sovereigns holding housing finance agency bonds (Fannie and Freddie Mac).

F) 2009 - US bails out municipal bonds (again) by underwriting the Build America Bonds (BAB) which covers interest payments for the states.

G) 2010 - US pressures EU to bail out itself while granting hundreds of billions dollars in currency swap guarantees

Notice a pattern here?

The current crisis is not materially different from past crises (except in the scale). America's net worth is TRILLIONS of dollars. We are the world's biggest consumer and driving engine. A few trillion here and there will not destroy us.

The formation of the EU itself would not have been possible without America's help. A continent that had been at war with itself for hundreds of years has endured 60 years of peace because of a US taxpayer funded NATO. European nations that were used to, on average, one war every generation suddenly found quiet. Even the Balkan conflict in the 1990s has been (largely) resolved through American military power.

Debt is fine as long as there is productivity growth behind it. The EU's formation was supposed to usher in a period of productivity. Instead, it produced a stagnant continent that has grown used to some of the highest living standards in the world. But how can governments pay for it?

Let's look at productivity gains. Growth from the last generation of innovative American companies (there is a distinct lack of start-ups in Europe due to business cultures and government tax regulations - Indeed, the tax burdens behind the EU bailout will stifle growth even more.) is falling.

The Microsofts, Dells, and Intels of the 1980s and 1990s have turned into moribund mega-corporations with smaller profit margins. Generally, past innovations are already factored into equity share prices. Maintaining the past pace of productivity will be difficult. Which is why the world is looking to the India's, Brazil's, and China's for the next big gains.

The Debts of the World: Where Do We Grow From Here?

2010-06-11T11:02:00.002-04:00

Growth is only one factor. The more important thing to examine is PROFITABLE growth. Let us examine a country that is always on the lips of pundits - China.

Much of China's growth is real but whether such growth is strengthening the economy is questionable.

Chinese growth, much like Japan in the 1970-80s, is living off the legacy of cheap, government controlled money and low prices. While the entire world was lauding the "Japanese economic miracle", the entire structure was rotten from within. The number of NPLs (non performing loans) grew steadily. Instead of writing off losses, the corporations - with the connivance of the state - covered up the losses with even more losses to keep the system alive. More alarmingly, the demographics began to shrink. All this came to a head on December 29, 1989 when the Nikkei reached an intra-day high of 38,957.44 before closing at 38,915.87.

The following 20 years were not pretty.

We are beginning to see the same things in China. Except China's 1 child policy will only make things worse.

Smarter people than me have already written volumes about this. But I'll put things in recent perspective. The spate of suicides in Chinese sweatshops is a symptom of a systemic problem - a corporate culture wedded to near term profit and nothing else.

Besides cheap labor do you know what the other Chinese competitive advantage is?

"Quality Fade."

Quality Fade is a term made by Paul Midler, an old China hand who is an importer agent stationed in southern China.

Made in China may be more expensive than you think. There are many reasons why a manufacturer would agree to make merchandise for next to nothing. One reason is that "switching costs" in manufacturing are high. It was important to many manufacturers to catch the order first. Later, once the importer was relaxed and the orders were assured, the factory could raise prices bit by bit, and then quality could be cheapened. After winning the initial order, many Chinese suppliers systematically degrade the quality of their production in order to cut costs.

I highly encourage all to read "Poorly Made in China" which covers this in more detail:

http://www.amazon.com/Poorly-Made-China-Insiders-Production/dp/0470405589

Or for those with less time:

http://article.nationalreview.com/395364/chinese-junk/john-derbyshire

The Debts of the Spenders: EU Pledges Unlimited Support for PIIGS Bonds

2010-06-10T11:55:00.002-04:00

June 10 (Bloomberg) -- Jean-Claude Trichet said the European Central Bank will extend its offerings of unlimited cash and keep buying government bonds as it tries to ease tensions in money markets and fight the European debt crisis.

“It’s appropriate to continue to do what we’ve decided” on purchases of sovereign and corporate bonds, Trichet, who heads the ECB, said at a press conference in Frankfurt today. Earlier, the central bank kept its benchmark interest rate at 1 percent. “We have a money market which is not functioning perfectly.”

The ECB is buying state debt and pumping unlimited funds into the banking system as part of a strategy by European policy makers to stop the euro region from breaking apart. While Trichet refused to bow to some investors’ demands for more details on the bond purchases, he said the ECB plans to offer further help to banks struggling to raise cash in money markets.

http://www.bloomberg.com/apps/news?pid=20601068&sid=aNbI444Ocv08

The Debts of the Spenders: US Homeowners Walking Away From their Mortgages

2010-06-04T00:20:00.001-04:00

A growing number of the people whose homes are in foreclosure are refusing to slink away in shame. They are fashioning a sort of homemade mortgage modification, one that brings their payments all the way down to zero. They use the money they save to get back on their feet or just get by.

“Instead of the house dragging us down, it’s become a life raft,” said Mr. Pemberton, who stopped paying the mortgage on their house here last summer. “It’s really been a blessing.”
This type of modification does not beg for a lender’s permission but is delivered as an ultimatum: Force me out if you can. Any moral qualms are overshadowed by a conviction that the banks created the crisis by snookering homeowners with loans that got them in over their heads.

http://www.nytimes.com/2010/06/01/business/01nopay.html?emc=eta1

The Debts of the Lenders: Chinese Bond Holders Demand Higher Interest Rates

2010-05-30T22:26:00.002-04:00

In a sign that bond holders of Chinese property developers are growing impatient, the market raised rates as the prospect of risk appetite diminishes.

Yields on the $3.9 billion of bonds issued by Kaisa Group Holdings Ltd., Country Garden Holdings Co. and seven other developers since January widened by an average 2.26 percentage points relative to Treasuries as of last week, according to data compiled by Bloomberg. That’s more than the 2.05 percentage- point increase in spreads for the seven dollar-denominated bonds sold by other companies in Asia outside Japan.
Investors are demanding greater yields to lend to China property firms, a sign they expect borrowers will have a harder time meeting debt payments amid a government clampdown down on lending. Goldman Sachs Group Inc. and Credit Suisse Group AG cut their profit estimates for Chinese real estate companies after a 12.8 percent rise in real estate prices in April from a year earlier spurred the state to increase regulation.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aPRgPERaqqQA&pos=2

The Debts of the Spenders: An Interesting Look at the US Stock Market

2010-05-28T11:10:00.001-04:00

Is the smart money always right? Take a look for yourself with the Commitment of Traders report as published by the CFTC and released every Friday. Note the large drop in OI in mid-March as small specs went bullish and big players reversed or just dropped out of the game altogether.

This hearkens to a point that popular Zerohedge blogger has repeatedly made - the stock markets are run by hi-fi trading machines and not real volume.

The Debts of the Spenders: British Austerity Package - 300k Jobs to Be Cut

2010-05-24T23:00:00.004-04:00

There was a time when the British Pound was considered a flight to safety "haven" trade. With measures such as these, perhaps it may regain that status once again. Will Greece have the courage to take such measures? Recent evidence shows that it alas does not.

http://www.timesonline.co.uk/tol/news/politics/article7134040.ece

The Debts of the Spenders: ECB Cuts Back on Bond Purchases

2010-05-13T21:56:00.003-04:00

After last weekend's pan-European bailout more details are beginning to emerge. Faced with internal dissent over rising inflation concerns, the central committee trimmed purchases of Spanish and Italian bonds. Most of the ECB’s bond purchases seem to have been made on May 10, the first day the rescue plan was in force, and buying has diminished since then.

Further details on exactly how they plan to sterilize or keep monetary purchases from spilling over into the broader market will be released later.

http://www.bloomberg.com/apps/news?pid=20601068&sid=alPFAHw0MnlE

The Debts of the Spenders: EU Agrees To Print Almost $1 Trillion and Buy Government Bonds

2010-05-09T23:49:00.002-04:00

"Death to speculators!" was the rallying cry heard round the weekend as European leaders struggled to contain the Euro from crashing. One wonders where exactly they will get the money to do so. The answer of course, is the printing press, or more accurately off balance sheet transfers to ensure a smooth flow of liquidity (e.g. credit moving around the world). Nearly all of these transfers will be done at the institutional level and between psuedo government agencies such as the IMF and World Bank. This measure is critical as it prevents runaway inflation from entering the wider economy. . . .at least temporarily.

http://www.bloomberg.com/apps/news?pid=20601087&sid=aeHrwqUq9G9A&pos=1

The Debts of the Lenders: Turkish Growth in Stark Contrast To Greek Shrinkage

2010-05-09T18:01:00.002-04:00

The whole irony behind the Greek drama is the concurrent rise of its age old rival, Turkey. A large part of the fiscal imbalances were brought about by military spending in preparation for a potential war in the Aegean over Cyprus.

But this conflict was ages ago and the political situation has calmed down quite a bit with the Turks routinely begging for entry into the EU zone every few years. The Turks have a dynamic, growing economy that is poised to overtake every other nation within the EU bloc. Indeed, the perenially high interest rate banking sector is finding itself enjoying a period of relative calm amid the chaos being wrought just a few kilometers away from its borders.

Perhaps nothing is more ironic than Turkey turning away the IMF at the very same time that its neighbor is begging for foreign intervention.

In March this year it sold $1 billion of 11-year dollar-denominated bonds at the lowest yield on record, after the government decided it did not need help from the International Monetary Fund.

If Turkey had joined the EU then its fortunes would've been tied to a moribund political economy with decisions made by bureaucratic vote instead of the independence necessary to launch itself upwards.

Additionally, the larger and more youthful demographic make for a more appealing picture than the image of aging Greek pensioners burning rubber tires or firebombing their local banking branches.

Finally, its close proximity to Iraq may be considered a boon instead of a burden. The security situation has calmed down considerably since the martial law era of the 1970s and 1980s when Kurdish insurgents ran amok throughout the countryside. While a de facto Kurdistan exists in northern Iraq, the US presence in the region has actually stabilized the situation instead of inflaming it. While Turkey may not be able to benefit directly from the oil wealth in Iraq, its economy may experience secondary bonuses such as improved trade links via a land route that was formerly closed off during the Sadam years.

Sources:

http://www.gfmag.com/latest/features/10256-features-turkey.html

http://www.bloomberg.com/apps/news?pid=20601087&sid=aqjIaXUwvdMs&pos=7

The Debts of the Spenders: UK Rejects EU Bailout Fund

2010-05-09T16:34:00.002-04:00

More to come later. This is a developing story.

EU leaders are worried that financial markets will continue to lack confidence in countries with high deficits.

Officials and diplomats in Brussels hope that a stabilisation mechanism will calm the international markets' fears about default in Europe.
But the loan guarantees are too much for the UK to swallow, and the UK Treasury will have nothing to do with them. Without the UK onboard the package looks pretty thin.

http://www.abc.net.au/news/stories/2010/05/10/2894423.htm?section=justin

The Debts of the Spenders: EU Nations Establish Emergency Fund to Defend the Euro

2010-05-07T23:47:00.003-04:00

Faced with a total collapse of the Euro, Eurozone leaders vowed to create a stability fund to save their currency. The bureaucratically stodgy institution was shocked to its core after months of haggling over the Greek bailout turned out to be for naught. Leaders believed the 110 billion Euro bailout package for Greece would be the backstop required to return confidence to the markets.

The ECB's normally placid meeting on Thursday failed to create confidence after ECB President Trichet refused to discuss the "nuclear" option of pulling a Bernanke (e.g. having the ECB buy sovereign debt). The lack of any meaningful price action in PIIGS market debt has forced 2 year yields to double digits this week. While attractive at first glance to junk buyers, the high yield reflects the market's concern that the Greek government will be forced to re-structure - e.g. pay less than face value - on government debt.

Instead, their actions served only to produce the largest rise in implied volatility ever - exceeding 2008 levels.

Now, Eurozone leaders are working furiously over the weekend to create a continental bailout package. Notably absent from the table however was any mention of buying government bonds. Failure to do so would result in European financial institutions - banks, pension funds, and insurance companies - facing enormous losses. There are no easy solutions here. Even a re-structuring of government debt obligations would result in further write offs. But at least it would be amortized over time instead of vanishing in a blink of an eye (e.g. kicking the can down the road for another generation to handle).

Some notable quotes:

“We will defend the euro, whatever it takes,” European Commission President Jose Barroso told reporters early today after the leaders met in Brussels.

“When the markets re-open Monday, we will have in place a mechanism to defend the euro,” French President Nicolas Sarkozy said. “If you don’t think that’s significant, you haven’t been to many EU summits.”

Europe will send “a very clear signal against those who want to speculate against the euro,” Merkel said.

All agreed on “the need for a clear, timely and strong response,” Canadian Finance Minister Jim Flaherty, who chaired the call, told reporters in Ottawa. “We hope to see a strong, early policy response in Europe.”

Europe’s unprecedented lending pledge has “proven insufficient to stop market contagion to the rest of the euro- zone periphery,” Michael Saunders and other economists at Citigroup Inc. said in an e-mailed note before the summit.

http://www.bloomberg.com/apps/news?pid=20601087&sid=azNNZZQK3AQI&pos=1

The Debts of the Spenders: LIBOR OIS Spread Widens to 2008 Levels

2010-05-06T17:07:00.002-04:00

Markets are pressuring Trichet to pull a Bernanke and have the ECB buy European government bonds (Bernanke was responsible for structuring the agency debt MBS program under the Federal Reserve).

May 6 (Bloomberg) -- Money markets show banks may be increasingly reluctant to lend to each other on concern that quality of collateral backing short-term loans is diminishing as government finances in Europe worsen.

The spread between the three-month dollar London interbank offered rate, or Libor, and the overnight indexed swap rate rose to the most in more than five months, reaching 13.4 basis points today. The so-called Libor-OIS spread has increased from 6 basis points on March 15.

http://www.bloomberg.com/apps/news?pid=20601087&sid=avw1eFn6Kxy4&pos=3

The Debts of the Spenders: Bond Vigilantes Call IMF's Bluff

2010-05-04T11:29:00.002-04:00

After pledging over 100 billion euros to bail out Greece, the IMF and ECB thought that the Greek contagion was over. They could not be more wrong. CDS on the other non-Greek PIIGS countries (Portugal, Italy, Ireland, and Spain) have expanded wider in anticipation of further bailouts while the Euro continues to sink like a rock. Fiscal stability, it seems, is irrelevant as the market is pricing in further bailouts.

Of course, the lenders of last resort, the US Federal Reserve, is always ready to step into the pipeline as a guarantor with swap lines (a la 2008).

Some questions that need to be answered before the Americans can step in:

- Will European MPs (members of Parliament) approve the package?
- What is the final bailout sum?
- What form will the aid arrive in?
- Will the IMF Completely Change the Rulebook because of Europe?

The Debts of the Spenders: Is the EU's Collapse Imminent?

2010-04-29T00:28:00.001-04:00

Greece's fiscal problems are weighing down the rest of the EU as fund managers ponder the potential end of monetary union.

http://www.bloomberg.com/apps/news?pid=20601087&sid=avEnrIJe4dI8&pos=2

The Debts of the Spenders - Dollar Strength Correlated with the Market

2010-04-22T22:37:00.003-04:00

Time for some technical analysis talk.

As you can see here, the US dollar has been making higher highs and higher lows on the daily chart. Additionally, the MACD and RSI have stayed above the water line. The dollar has also moved back above its 50 day MA.

Note the similarity to the S and P 500 chart.

The Debts of the Spenders: Bill Clinton Regrets Repeal of Glass Steagall

2010-04-18T11:46:00.002-04:00

Former US President Bill Clinton admitted to bad judgment in a tv interview. Specifically, Clinton blamed Robert Rubin and Larry Summers for deceiving him about the risks of unregulated derivatives products. Under Clinton, the Depression era Glass Steagall Act that separated banking activities from trading was dissolved.

Provisions that prohibit a bank holding company from owning other financial companies were repealed on November 12, 1999, by the Gramm-Leach-Bliley Act, named after the influential senators who were bought and paid for by the banking community. As for Robert Rubin, immediately after his term as Treasury Secretary expired, he was appointed head of Citigroup Travellers with a $1 billion/annual paycheck. Completely coincidental? You decide.

Clinton also said that Republicans who controlled Congress would have stopped him from trying to regulate derivatives. “I wish I had been caught trying,” Clinton said. “I mean, that was a mistake I made.”

http://www.bloomberg.com/apps/news?pid=20601087&sid=aX1CAxJtU6X4&pos=2

The Debts of the Lenders: China to Curb Real Estate Bubble

2010-04-17T12:14:00.002-04:00

Affordable housing in China is a joke. Instead, the real estate market - along with the stock market - has turned into a giant casino. Fund flows from Chinese investors are contributing to the bubble because of strict capital controls that remain on where, what, when, and how (regular) native Chinese can spend their funds. Thus, this news is encouraging - even if it appears to be yet another round of mere talk instead of more substantive action.

Surging Prices

Property prices in 70 major cities surged 11.7 percent in March from a year earlier, the most since records began in 2005, government data showed last week.

In an April 15 statement after the release of first-quarter numbers for gross domestic product, the State Council said that local governments have failed to control speculation. Besides limiting the risk of price bubbles, policy makers want to keep housing affordable.

http://www.bloomberg.com/apps/news?pid=20601087&sid=auFNiiN1tB7Y&pos=2

The Debts of the Spenders: Bond Buyers Demand Protection Against Downgrades

2010-04-05T01:53:00.002-04:00

Step-up bonds are bonds whose interest increases if a borrower is downgraded (but not defaulted). According to a report by Bloomberg, sales surged to $37.3 billion in March, or 12.4 percent of all debt issued.

Please note that most of these bonds are issued by PRIVATE companies as opposed to sovereign entities such as national and/or local governments (Greece and various American cities/states/local governments come to mind).

Moreover, it is important to distinguish step-up bonds from credit default swaps as they focus on interest rate increases as opposed to an outright insurance payment (which is usually triggered only by default. This response is not unusual considering that the greatest inflow into bond funds by investors occurred in 2009. There is not much room left for additional gain so those corporate issuers late to the refinancing party must offer additional incentives to attract increasingly discerning lenders.

The Debts of the Spenders: More on Negative Swap Rates

2010-04-02T23:36:00.003-04:00

This post is a continuation of the immediate prior post. Here are some questions that I received.

Q) Wasn't the credit crisis driven in part by low interest rates that made investors search for higher yield (risks receiving too little attention)?

A) Yes. But this is part of the West's "Extend and Pretend" recovery rally. If a bank wrote down $40 billion loss in 1 year, they could theoretically break even by making $10 billion/quarter for 4 quarters. Obviously this enthusiasm is not reflected by emerging market nations like India and China which have tried to reign in their own markets by raising rates and/or withdrawing liquidity.

Unlike 2004 (when the markets were also preparing for the end of Quantitative easing) there is a coordinated movement among Western governments (US, Canada, UK, and the Eurozone) and Japan to keep rates low.

Q) Can it be that the negative swapspread partially reflects a credit concern in Treasuries (if cannot be good that Buffett borrows at lower rates than Treasuries - http://www.linkedin.com/redirect?url=http%3A%2F%2Fwww%2Ebloomberg%2Ecom%2Fapps%2Fnews%3Fpid%3D20601087%26amp%3Bsid%3DaYUeBnitz7nU&urlhash=NIeB )?

A) Yes and no. It is not so much credit concern as it is the supply issue. Many bond traders (myself included) believe the 10 year will break 4% by this summer. Temporary factors contributing to a rate rise include Obama's Health Care monster bill. But a weak economy driven by deflation and labor figures should drive the 10 year yield below 4% again by December.

Additionally, the Europeans look very weak. Where are traders going to park their money? In pounds and euros? Ha.

The US certainly is not suffering from the same legitimacy questions as Greece, the UK, or Eurozone. That is because the US has 2 magic bullets to refinance its needs - China and Japan.

Q) Why are companies hedging all their long-term interest-rate risk exposure? Doesn't that increase their risks if short-term rates rise again? Do they have too much of a short-term focus?

A) See my answer regarding coordinated Western govt action on rates. The Japanese are also doing their part to fuel the carry trade. So long as they borrow in dollars or yen then there should not be a problem. The market seems confident about the remainder of 2010 but is unsure about the next few years. Hence the need to hedge.

I am also looking at the options volatility for the tone of the market.

The following is a direct quote from http://www.optionszone.com/market-commentary/options-activity/2010/03/iron-condors.html

"We seem to be at a crossroads with options these days. On one hand, most
options have an implied volatility near 52-week lows. Who would want to sell
options when they are this cheap?

On the other hand, the only important aspect of an option's volatility is whether it is too high or too cheap relative to the volatility of the underlying instrument itself going forward. Spreads tend to work best as they have the defined risk and defined reward. You can make the same risk case with a straight buy though. All things considered, I prefer taking in credit."

I slightly disagree with the author to some extent and believe that sometimes it makes sense to lay out some debits at these low volatility points. He is championing an iron condor strategy - something that can be very expensive for traders to take on.

Q) It is a sign of confidence that investors are willing to buy long-term credit. But will these turn out to be good investments? The term 'wall of debt' has been used (e.g. http://www.thedeal.com/newsweekly/features/that-worrying-wall-of-debt.php

A) The best bond deals are over. Gone are the days when you could buy at vast discounts to par and make 400%-500% in a bond (no, I am not making those figures up - see the preferred/ hybrid offerings for US financials in 2009). The nature of Wall Street is a herd driven mentality. These are the latecomers who are trying to sell their offerings to investors. For the past few months, bond fund inflows have beat equity inflows. That is why forward thinking traders are shifting focus to equities again and commodities. Just look at oil's rise. Corporate coffers are full of cash again and CFOs may commit to stock buy backs this summer (but probably not at these technicals).

The Debts of the Spenders: Explaining Negative 10 Year Swap Rates

2010-03-31T22:03:00.002-04:00

The yield inversion is a sign of hedging risk against more volatility in the coming months as desks are worried about a potential rise in rate risk.

One possibility behind LIBOR being less than the 10 year yield is that major banks are not positioned properly for it and will lose heavily. But this is not the same thing as a "Black Swan" type event that some commentators are calling for. Certainly not as bad as when the TED spread >4 in Fall 2008. Eurodollar forward contracts are not pricing in disaster as they continue to reflect a belief in ZIRP through the end of 2010.

Indeed, the Fed has stated it has no intentions to raise interest rates soon as they are still testing ways to withdraw the quantitative easing policy that was initiated.

There are three Fed meetings between now and the expiration of the Sept Eurodollar contract (9/13).

Apr 27-28

June 22-23

Aug 10

The job and housing market remain very weak. Inflation remains in check.

In fact, the negative swap rate seems to be NORMAL given the search for yield among fund managers (e.g. demand for higher-yielding assets such as corporate bonds and emerging market securities). A bond is a contract that involves at least two parties. The fund manager buyers are one party. The other is the bond issuer seeking to hedge risk (primarily interest rate risk) .

With low interest rates projected to stay (and the majority of corporate deals still dollar denominated) at ZIRP for the remainder of 2010 and all these corporate borrowers (bond issuers) seeking to sell their debt it is no wonder that swaps turned negative.

But what of the timing you ask at the end of March? The timing can be explained by the end of Bernanke's TOMO MBS program. With the Fed seeking to exit the agency debt market, there are players eagerly waiting to enter the private market again (agency debt market dried up by Q3 2007). There are even NEW private securitization deals happening again (my colleagues at the NY Bar say there are signs of greater deal flow again in the pipeline). The nature of corporate America is to shy away from risk so while they are all eager to make some money they are also reluctant to make the first move. All this explains the heavy demand for swaps.

The Debts of the Spenders: Will the Private Sector Replace the Fed as a Buyer of Cheap Mortgages?

2010-03-30T15:13:00.003-04:00

This is the thought provoking question asked in a recent Bloomberg article that posits the possibility of private investors returning to the mortgage bond market after the Federal Reserve is due to end its agency TOMO buying programing of Fannie and Freddie linked debt. The Fed's program has been instrumental in keeping long dated (10+ years) fixed rate mortgages below 5%-7% for over a year but is due to expire within a few days. It seems like such a long time ago but the Fed's intervention in the agency debt market was designed to be a temporary measure

The article's writer cites the narrowing spread as indication of just such a transition:

In December 2008, two weeks before the start of the Fed bond-buying program, the spread between the 10-year government bond yield and the average U.S. 30-year fixed mortgage rate was 3.07 percentage points, the widest since 1986, as investors demanded higher payment to compensate for risk. Last week, the difference was 1.14 percentage points, narrower than the 20-year average of 1.65 percentage points.

“Private buyers are going back into the market to pick up where the Fed is leaving off,” said David Berson, chief economist of PMI Group Inc. in Walnut Creek, California. “Credit spreads have narrowed significantly, and not just for mortgages, because investors believe the worst of the financial crisis is behind us.
Fed policy makers have made it clear in statements following the end of rate-setting meetings that they will restart the mortgage-bond buying program if needed, according to Pandl. That “backstop” has reassured investors and encouraged them to re-enter the market, he said.

Much of the demand for mortgage bonds is coming from money managers seeking to diversify their portfolios, said Berson, of PMI Group.

“Investors are full up with Treasuries,” he said. “They haven’t been able to diversify into mortgage bonds because the Fed has been buying the bulk of them. Give them an opportunity to diversify into that market, and they will.”

Source: http://www.bloomberg.com/apps/news?pid=20603037&sid=aU20MV8VOQfQ

Additional reading:

http://www.calculatedriskblog.com/2010/03/countdown-fed-mbs-purchase-program-only.html

http://www.urbandigs.com/2010/03/rate_watch_fed_mbs_purchase_pr.htm

http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2010/Investment+Outlook+March+2010+Bill+Gross+Dont+Care.htm

The Debts of the Spenders: The US Health Care Bill

2010-03-29T14:42:00.001-04:00

Much of the significant tax impact appears to be delayed, but some of the current highlights include:

- An additional 0.9% Medicare payroll tax on income in excess of $200,000 for singles or $250,000 for married couples.
- An additional 3.8% Medicare "unearned income" tax on investment income to the extent it exceeds the same $200,000 for singles and $250,000 for married couples threshold - calculated as a 3.8% tax on the LESSER of investment income or the excess of the taxpayer's income over the aforementioned thresholds.
- A 40% nondeductible excise tax on insurance companies and plan administrators on high cost ("cadillac") insurance plans, if the premiums exceed $10,200 of individuals or $27,500 for families (limits adjusted for inflation).

http://tax.cchgroup.com/legislation/Senate-Healthcare-Fixes-Bill-03-25-10.pdf

The Debts of the Lenders: China's Growing Bubble

2010-03-27T17:41:00.002-04:00

The US - China relationship used to be marked about hand wringing recriminations about human rights and Taiwanese arms sales. Those still exist but have been relegated to the backburner before the realpolitik of economic change. China's insistence on keeping a yuan-dollar peg has resulted in a growing amount of inflation and speculative bubbles building up within the country's borders. Shut off from access to Western capital outlets (and after the events of 2008 can you really blame the country's regulators for being suspicious of US-British style finance), Chinese speculators have instead poured money into the country's dual vehicles of wealth acquisition - the stock and property markets.

Indeed, these market malinvestments have resulted in some pretty distorted changes:

SHANGHAI, China — In what may be the hottest real estate market on the planet, one fact of life seems extra cruel. In Shanghai, young women expect their boyfriends to buy a home before proposing.

“There’s a joke that goes Shanghai women can’t find husbands because they want a house, a car and a RMB1 million [$150,000] income,” said 28-year-old (male) sales rep Su Bei.

In truth, choosier women even go as far as to require that a spouse-to-be have paid off the mortgage entirely before popping the question.

Source: http://www.globalpost.com/dispatch/china-and-its-neighbors/100302/china-economy-shanghai-real-estate-marriage

HONG KONG—One is a China state tobacco company. Another, a Japanese ramen chain. And finally, there is an obscure Hong Kong semiconductor maker.

What they have in common: They are some of the latest companies to jump onto the real-estate bandwagon as prices soar to gravity-defying levels in Hong Kong and mainland China. Some experts see the growing involvement of nontraditional players as yet more troubling evidence of froth in both property markets.

Last week, a small maker of diodes and transistors called Sino-Tech International Holdings Ltd. shocked investors by announcing that it was "diversifying into the property sector," buying a luxury three-story residence in Hong Kong's swank Peak district for more than HK$280 million (US$36 million) in cash, one of the biggest sums ever for a property here.

Source: http://online.wsj.com/article/SB20001424052748704211704575139501049097716.html

The Debts of the World: Low (US) Interest Rates Continue to Dominate Discussion

2010-03-27T16:58:00.006-04:00

It's been a while since I last posted because I have been busy with other things in my life. Like focusing on passing 2 state bar exams and working full time. Anyway, I have certainly not been idle on the investment front.

The ongoing credit driven events in Greece and China have driven government yield premiums to higher highs as can be seen here in this dynamic yield curve chart that is overlaid with the benchmark US S&P stock market index:

http://stockcharts.com/charts/YieldCurve.html

Is this signs of a normalization?

Late last August, the markets were driven by the inverse dollar - risk premium trade where a lower dollar was directly correlated with higher asset prices in risk related trades such as commodities (and commodity linked currencies like the Aussie Dollar) and equities (particularly emerging market equities). Now, that correlation seems to have weakened with the dollar rising in tandem with benchmark interest rates.

Indeed, markets are continuing to price in a market driven by low US interest rates through the end of 2010 as evidenced by the Eurodollar futures contract (there are 3 more contract dates left in 2010 - June, September, and December. All 3 show that traders expect a continuation of low rates. For brevity purposes, the nearest contract date, June, is listed here).

The Debts of the Spenders: Cities Weigh Chapter 9

2010-02-19T15:45:00.003-05:00

Chapter 9 is a seldom used term to describe municipal bankruptcy provisions (re-organizations) if a city or other local government branch falls behind in its financial obligations; e.g. where its cash flow has turned substantially negative. This is not new. Similar fears afflicted the muni debt market in fall 2008 when nearly every financial sector turned south.

But savvy players like PIMCO's Bill Gross saw a chance to buy muni debt and those managers who followed made a tidy return on the severely marked down bonds. Their surge in price was part of a greater tide lifting all boats in the 2009 fixed income rally where HY (high yield; aka junk bonds) outperformed every other sector - equities, commodities, and FX. Munis have historically been considered "safe" as their default rates are a lot lower than private sector actors. The wealthy also use muni's as tax shelter vehicles because many states and jurisdictions make their bond returns tax free for local residents.

Is there another opportunity available here?

Maybe. Maybe not. The environment of fear that led to a technically and fundamentally oversold market does not exist today. Or at least not yet.

http://online.wsj.com/article/SB10001424052748704398804575071591602878062.html?

Agricultural Update: El Nino Waning in 2010?

2010-02-16T17:47:00.004-05:00

The widely followed Australian Bureau of Metereology issued its report that the risks of El Nino are lessening. This is important because it means that regular rainfalls will return, which is bearish for agriculture prices since there is less uncertainty over crop yields. But on the other hand, the end of El Nino's warm water effects indicate that the ever volatile energy markets for crude and natural gas may spike in the coming months because of an increase in hurricanes.

Indeed, contracts for active CME grains (May contracts) and Nymex crude (August) are already beginning to display this seasonal effect.

You can click here to see a dynamic stop action map of Pacific sea temperatures from November 2009 to the present: http://www.elnino.noaa.gov/

Australian Bureau: Pacific Indicators Suggest El Nino Waning

Temperatures in the Pacific Ocean suggest an El Nino event is waning, though current patterns are typical of such an event, the Australian Government’s Bureau of Meteorology reported Tuesday.
Surface and sub-surface temperatures remain warmer than average in the equatorial Pacific, but climate models suggest these will cool in the coming months but remain above El Nino thresholds
until April or May, according to the bureau’s weekly tropical climate note.

El Nino events are typically associated with above average sea temperatures in the eastern and central tropical Pacific and are usually but not always associated with below normal rainfall in the second half of the year across large parts of southern and inland eastern Australia. An El Nino can have a disastrous impact on agricultural production in eastern Australia, particularly for non-irrigated crops such as wheat.

The bureau’s Southern Oscillation Index, another indicator of an El Nino, measured minus 23 for the 30 days ended Feb. 14, falling sharply from minus 10 in January. An El Nino typically is associated
with strongly negative values for the SOI, sustained for several months around minus 10 or lower.
The recent rapid decline in the SOI can be partly attributed to several tropical disturbances affecting French Polynesia, it reported.

Source: CME News For Tomorrow

The Debts of the Lenders: Chinese FDI Surpasses US Overseas Investment

2010-02-15T22:38:00.003-05:00

In the 1992 US Presidential campaign, Independent candidate Ross Perot famously stated that ratification of the NAFTA treaty would lead to the "giant sucking sound of thousands of US jobs" to foreign locales such as Mexico. Fast forward to today and the focus has shifted from Mexico to another cheaper locale, China.

For years, most attention on China focused on FDI or foreign direct investment. In the 1990s, low interest rates in Japan drove investor funds to the mainland in search of higher yield (This trend is still continuing). These investors were later joined by adventurous Western (mostly American) funds in search of investment potential. Growth really took off though with the death spiral of US manufacturing as firms continue to offshore manufacturing away from North America.

But, 2009 marked the year when investment flows went the other way - from China towards the US. Does this mean that the dividends of globalization are finally starting to pay off for Washington lobbyists? Apparently not.

While Chinese investment remains very diverse, the focus of the political leadership is all too apparent:

. . .Chinese outbound investment (whether in the US or elsewhere outside of China) is still predominantly focused on securing natural resources and forward integrating into sources of critical raw materials deemed integral to China's manufacturing infrastructure and industrial capacity.

http://www.atimes.com/atimes/China_Business/LB02Cb01.html

Meanwhile, US workers continue to wait for the long promised fruits of global integration. With real unemployment at record highs and no economic recovery in sight for the average American, they may have to wait a while longer. So far, it looks like Ross Perot may have been right.