June 2008

Oil quotes zigged and stocks zagged yesterday, but the net result was not quite what we would have predicted. With July Crude off a whopping $3.34 on the day, we might have expected the Dow to leap with exuberance, given that investors have been consumed by worry lately about the skyrocketing oil prices. Instead, the Dow finished the day with a modest 69-point gain. What this suggests is that investors don’t trust a mere one- or two-day selloff in energy futures. Is it perhaps because, each time this has occurred in the recent past, prices have rebounded to new highs with stunning speed?

We have no doubt that a dramatic fall in the price of oil would be bullish for stocks. But judging from yesterday’s price action in the latter, the decline would have to be sustained and significant in order to coax wary investors from their bomb shelters. A week during which oil futures have fallen by, say, $20-$25 would probably do the trick. But is this likely? From a Hidden Pivot perspective, despite yesterday’s selloff, odds are still with energy bulls at the moment, since July Crude has an outstanding rally target $2.40 above the recent record high at 135.09. Moreover, in off-hours trading Tuesday night the July contract was turning up without having even gotten close to the 126.48 target of a corrective leg. So far, the bullish turn has come from a low of 128.10, implying that yesterday’s decline may have exhausted short-term sellers.

Duck and Run

Our bullish outlook would change, however, if the July NYMEX contract, currently trading around 128.75, were to fall below 123.74 today. Alternatively, a thrust above 129.46 would be warning bears to duck and run. Speaking of bears, a CNBC guest yesterday suggested that oil players with a high tolerance for risk should start shorting crude in such quantity as to burden buyers with the realities of supply. While we agree that the rally long ago exceeded such rationalities, the violent force and persistence of short covering in recent weeks could conceivably leave even the Saudis hung up on the ropes if they were to try to impede it prematurely.

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Get a Chat-Room Pass

The Rick’s Picks chat room is the place to be if you’re looking for tradable ideas in real time. Gold and silver traders in particular can benefit, since the room attracts experienced traders from all over the world at all hours of the day, particularly during U.S. market hours. If you would like a free one-day pass to check it out, click here, and then on the green banner.

The Fed has been attempting to stimulate the economy like never before, but will it work? Some economists and pundits say it already has worked and that the U.S. has dodged the bullet of recession. These people are either dolts or publicity-seeking liars, or a combination of both, and we’d suggest tuning out their blather, since there is no factual basis whatsoever for their assertions that the economy has bottomed.

And on what do these mountebanks base their optimism — other, perhaps, than blind faith and/or an overweening desire to appear on television? Merely because no large banks have failed in more than a month is hardly reason to infer that our troubles are over. Far from it. And yet, the huckstering economists who would have us believe they see light at the end of the tunnel apparently have extrapolated their bullish scenarios from a recent uptick in retail sales that was due more to higher gasoline prices than any other factor. By this logic, we should expect the housing market to begin a powerful recovery as soon as gas reaches $5-$6 a gallon.

A Trillion Wasted

To the contrary, the economic recovery that more than a trillion dollars worth of Fed stimulus and bailouts has yet to engender can occur in one way only: via a resurgence in home prices. Nothing else that we can conceive of is capable of reviving consumer spending, and without plenty of it, the illusion of an economy barely creeping along that some still cling to will soon give way to the grim realities of subsistence.

How would we know if and when a recovery is under way? Look no further than the ‘For Sale’ signs on your neighbors’ lawns. Although this is the last place a navel-gazing punditry would think to look, it is assuredly the first place where we might find a glimmer of hope. For the present, though, it would appear that the Fed’s desperate and ill-conceived tactics have stimulated inflation in just about every asset class except housing.

Denver Parcel

If it were otherwise, homes in the Denver suburban neighborhood where I live would almost surely be among the first to feel the benefits, since a giant energy company has decided to locate a think-tank on a 450-acre parcel less than a mile from my house. In fact, homes here have lost about ten percent of their value in the last year, prices are continuing to drop, and when a ‘For Sale’ sign pops up on a lawn, it stays there until the seller either lowers his price significantly or gives up.

So if some pundit declares that the recession is over without ever having begun, don’t expect him to explain how he knows this, since he would only make a fool out of himself if he tried. To say that we are coming out of the woods is wishful thinking at best, a contemptible and brazen lie at worst.

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Get a Chat-Room Pass

The Rick’s Picks chat room is the place to be if you’re looking for tradable ideas in real time. Gold and silver traders in particular can benefit, since the room attracts experienced traders from all over the world at all hours of the day, particularly during U.S. market hours. If you would like a free one-day pass to check it out, click here, and then on the green banner.

We put out some bearish targets a while back, not expecting them to be reached so quickly. Now what? Our original advice called for bottom-fishing in the E-Mini S&Ps, Citigroup and the QQQQs, but we are seldom eager to attempt this when price targets are reached in the final minutes of the day, as occurred yesterday in two of the three vehicles. At the bell, stocks looked like they wanted to keep falling, but this must be weighted against the fact that index futures were actually wafting higher in after-hours trading. Granted, the buying wasn’t very strong, and by early evening the futures had eked out only a 2.50-point gain from their intraday lows. But any such buying, no matter how feeble, should serve to remind us that profit-taking by shorts will tend to interrupt even the most devastating selling panics.

Will yesterday’s near-panic continue into week’s end? We may have an answer early in Friday’s session, since the E-Mini S&Ps were approaching a Hidden Pivot support that looked well capable of generating a tradable bounce. (See Tuesday’s Touts for a detailed trading strategy.) If sellers turn the support into pulp, though, it would be warning buyers to move to the sidelines. The S&Ps have been very predictable lately, even if they’ve taken their sweet old time getting to their targets. We’d touted a bearish price objective at 1291.25 a while back when the futures were trading about 40 points higher. Because that was a fairly important Hidden Pivot support, we’d expected it to provide more support yesterday than it did. The seven-point bounce that occurred precisely from that number was the best of the day, but when the pivot gave way a little more than an hour later, it was signaling more, and probably considerable, weakness ahead.

Fantasyland

The myriad reasons for yesterday’s selloff are so obvious that no one could have been surprised by it. What does surprise, however, is that even after the prolonged slide begun last October, the Dow is still within 20 percent of all-time highs. This is particularly baffling, given that residential real estate values, the backbone of America’s credit-based economy, are falling more steeply now than during the 1930s. Add to that the imminent failure of more large banks and the almost certain bankruptcy of some of the country’s biggest manufacturing concerns, and you might get the impression investors are still living in fantasyland.

With the economy looking more precarious, even, than in 1929, the last thing in the world we might expect is for the Fed to start raising interest rates. But perhaps our colleague Steve Saville has a point when he suggests that the Fed seize the problem by the scrotum (our metaphor, not his) with a shock-and-awe tightening of 50 basis points. That would surely pop the bubble in crude oil and other commodities, which in turn could help mitigate the trade deficit and some inflationary pressures by pushing up the dollar. That would hardly begin to solve America’s financial problems, but at this point it is not necessarily certain, in the final reckoning, to make them worse.

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Last Chance to Take Seminar

Because of family vacation plans, I will be able to offer the Hidden Pivot Seminar only once this summer ‘ on two consecutive weekday evenings, July 23 and 24. If you’ve been thinking about signing up, now is the time to do it, since once this class is full there will not be another opportunity to take it until fall. Click here, and then on the ‘Upcoming’ tab to register; or here if you would like more information as well as a detailed description of the Hidden Pivot Method and a free Hidden Pivot calculator (our latest model, perfect for beginners).

(Click on text to enlarge)

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Saving America

We don’t have any easy answers, but we’re hoping to hear from readers with ideas about how to return the U.S. economy to health. The person who submits the best essay on the topic What Will Save America will receive not only a scholarship to the Hidden Pivot seminar, but also unlimited access to post-graduate tutorial sessions held each week during market hours. The value of this package is $1,150, and a week into the competition we’ve received no fewer than 21 submissions, including one that argues that Americans need, more than anything else, to get serious about diet and exercise.

Essays should be 750 words or less and must be received at this e-mail address by no later than July 15. For details about the Hidden Pivot seminar and comments from those who have taken it, click here.

Our own idea about how to save America is to become a global leader in energy. A solution that works for the whole world would be a triumph for Yankee know-how on a par with the invention of the automobile assembly line. To stimulate thought on this topic and others, we will be presenting occasional guest commentaries by people with backgrounds in science and engineering. Economists need not apply. In the meantime, we welcome any contributions at the e-mail address linked above. We’ll print the best of them once the competition has concluded next month.

Small wonder that Congress’ approval ratings are wallowing down around 14 percent these days. They could go even lower, too, by the time the World’s Greatest Deliberative Body’s latest Foreclosure Rescue Plan plays out. Have you heard about it? This legislative barf-bag is already attracting its share of flies, and it’s not even law yet. Everyone wants a piece, and the Congressional Black Caucus of course thinks that it doesn’t do enough to address the needs of African Americans. (For a complete list of all others whose needs may not have been adequately addressed, please consult the national phone directory on the Internet.) But, get this, some allegedly Conservative “Blue Dog” Democrats have the chutzpah to ask who’s going to pay for it. Not to worry, since it will only be providing a measly $300 billion to the FHA, which would channel the money to “distressed” homeowners. Too bad taxpayers were not given the option of betting it all on the spin of a Big Six wheel. At least that would have given them a sporting chance of seeing a return on their money.

The shaping of this legislative turd has been duly reported on the news pages of the Wall Street Journal, but you have to read Tuesday’s lead story to get a bracing whiff of it. What it will provide, first of all, are the kind of mortgage loans that led to the “subprime mess” in the first place — which is to say, loans to homebuyers who cannot come up with a downpayment. The private sector is no longer making such loans, and the FHA itself has told its benefactors on Capitol Hill that it no longer wants to make them either. Of course, that didn’t prevent the bill from sailing through Congress. As Thomas Sowell once said, “There is nothing so bad that politics cannot make it worse.”

How Bad?

How bad is “worse”? Well, consider the advertisements that some homebuilders have been using to drum up business when the new funds come available, presumably to the kinds of home buyers that private lenders would not touch with a ten-foot pole. D.R. Horton is promoting “100% financing” for some Maui condos that start at $498,000. and in Seattle, reports the Journal, local builder Quadrant Corp. is advertising townhouses that ‘can be purchased with as little as $500 down. ‘Use your coffee budget to move into a new home,’ says an online promotion.’ ” And in St. Louis, the Journal notes, another builder is promoting its suburban homes with an enticement for those “looking for something to spend [their] economic stimulus check on.’

We reel at the thought of this hair-of-the-dog solution being trotted out to counter the housing bust. Can anyone be so stupid or gullible as to believe that opening the door wider to distressed buyers will ultimately help the real estate market?

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Saving America

We don’t have any easy answers, but we’re hoping to hear from readers with ideas about how to return the U.S. economy to health. The person who submits the best essay on the topic What Will Save America will receive not only a scholarship to the Hidden Pivot seminar, but also unlimited access to post-graduate tutorial sessions held each week during market hours. The value of this package is $1,150, and a week into the competition we’ve received no fewer than 21 submissions, including one that argues that Americans need, more than anything else, to get serious about diet and exercise.

Essays should be 750 words or less and must be received at this e-mail address by no later than July 15. For details about the Hidden Pivot seminar and comments from those who have taken it, click here.

Our own idea about how to save America is to become a global leader in energy. A solution that works for the whole world would be a triumph for Yankee know-how on a par with the invention of the automobile assembly line. To stimulate thought on this topic and others, we will be presenting occasional guest commentaries by people with backgrounds in science and engineering. Economists need not apply. In the meantime, we welcome any contributions at the e-mail address linked above. We’ll print the best of them once the competition has concluded next month.

Yesterday we offered yet another installment of our running dialogue with iTulip founder Eric Janszen concerning whether hyperinflation or deflation is more likely to destroy the U.S economy. We hesitate to call it a debate because we’ve never thought those in the inflationist camp have a leg to stand on. We’ll believe hyperinflation is possible when the appraised value of homes in our neighborhood hit the billion dollar mark and wages rise commensurately.

Below is the concluding portion of our most recent back-and-forth with Eric. He begins with the fantastic notion that the ‘adjustments’ taking place in the economy right now are likely to continue for years. We strongly disagree and see a cataclysm ahead.

Eric: This will go on and on for years and years as living standards decline. Inflation is easier for people to adjust to than you’d think, certainly easier than 25% unemployment and no money around to buy anything as was the policy choice in the 1930s as wealth holders pressured the State to stick to the gold standard which tied the Fed’s hands to create inflation. As soon as the US went off the gold standard in 1933 and gold was re-priced, an instantaneous spike in inflation from -10% (deflation) to +15% (inflation)

resulted. And that after thousands of banks failed and the banking system had basically cratered. Those who hold fast to the theory that we are going to see commodity and wage price deflation as an outcome of this credit bubble don’t seem to understand this part of the history of the last US credit bubble.

A Bubble Like No Other

Rick: History, like statistics, is more often than not a damnable lie, and it is a brazen intellectual lie to suggest that there has ever been a credit bubble even remotely like the one that is now deflating. In fact, never before in history have households operated like hedge funds, borrowing against the inflated equity value of their homes. When you explain to me how price and wage inflation can continue with home values falling and corporate bankruptcies beginning to cascade, then we can return to our debate. Another historical fact working against us is that the U.S. economy was in infinitely better shape when the stock market crashed in 1929. The dollar was sound; household debt was almost non-existent; 30% of U.S. workers were tied to the agricultural economy — living off the land, so to speak; American’s jobs were far less specialized and esoteric — which is to say, workers actually produced things back then; and, the economy could actually be measured — in ingots-of-steel-produced and wattage of power generated. Nowadays, we have imbeciles with economics degrees to interpret “productivity” figures in such a way as to reassure us that we are indeed productive. In fact, we are no longer productive enough, even, for a middle class to scrape by without borrowing from foreigners who truly are productive. All of these factors lead inescapably to the conclusion that Second Great Depression will be much worse than the (deflationary) First.

Eric: If I’d been forecasting deflation for years and a Google news search produced 136 times as many results for a search on inflation versus deflation (142,539 vs 1,043), I’d be looking to make some adjustments in my model.

Rick: I don’t model my thinking on what Google tells me the average idiot finds interesting.

Stellar Record?

Eric: The only major adjustment that I’ve had to make is my forecast on long term interest rates. I expected they’d have turned up by now. Have a friend who is a hedge fund manager running $1B tell me in March he was finally taking huge short positions in long treasuries. He moved into the 10 yr at 3.34% and now it’s at 4:16%. Good move. Here’s a surprising voice added to the inflation chorus: When asked about the potential for stagflation, a combination of weak growth and high inflation, Greenspan said, “Oh certainly.” Greenspan also said, contrary to the opinion of many, that there isn’t a commodities bubble building. “Once you get inflation pressure starting to emerge, you don’t get bubbles.” he said.

Rick: Greenspan’s reputation as a political hack and dissembler is sealed forever. He’ll be lynched if he’s still around in five years. Anyway, I’d be grateful if you would provide me with a bullet-point synopsis of the major economic events that you expect to occur over the next 7-10 years. That will be the easiest way for me to determine whether I may have misunderstood you. Do we perhaps envision the same endgame — an economy in smoldering ruins, credit markets wrecked for at least a generation, widespread poverty and unemployment to match or exceed the Great Depression, and the U.S. having to rebuild its manufacturing capacity almost from scratch in order to make an honest living in the global marketplace? If that’s stagflation, or hyperinflation, then you needn’t bother to respond.

Penguin Book

Eric: I’m writing a book for Penguin ['The New New Deal'] that explains a tough transition period. The recession that the US is entering in the early part of 2008 is not a

typical business cycle recession or even a post bubble recession as occurred in 2001. The collapse of the housing bubble and the energy price shock are the triggers that started a process of major structural change in the US and World economy. When the transition is over in a decade, the US economy will hardly resemble its current form:

* Dependence on foreign borrowing to finance consumption and operate the government will end and reverse

* Dominance of the Finance, Insurance and Real Estate (FIRE) sectors of the economy for economic growth will give way to new productive industries in transportation, energy, and communications

* Trade deficits that started in the early 1980s will reverse and the US will begin to run a trade surplus

* Burden of economic rent extraction in the form of interest on public and Private sector debt will be lifted via a combination of inflation, restructuring, and debt cancellation

* Low national and household savings rates will rise to 1960s levels

* Consumption will decline by half, from 70% of GDP today to 50% of GDP

* Energy intensity, the amount of energy needed to produce a dollar of GDP growth will decline by half, led by conservation initiatives

The US will experience the transition as a series of recessions which, cumulatively, may be as severe as in the 1930s, but inflationary versus deflationary. We are seeing the first of these now.

The New New Deal asks and answers:

How did we get into this mess?

* Why have US financial markets been in turmoil for over a year?

* Why has the dollar weakened over 40% since 2002?

* Why is inflation rising?

* Why is unemployment rising?

* Why are asset prices falling?

How are we going to get resolve our crises?

My publisher doesn’t want me sharing the solutions part of the book, but basically the idea is that unlike the old New Deal, this time we unleash markets on the problem, with equity versus debt based financing.

Rick: An interesting list, all of it at least plausible as far as I’m concerned. But I still cannot buy your “soft landing” scenario for real estate, since the housing crash is completely overwhelming political attempts to deal with it. Also, I am skeptical that the U.S. will be able to retool in a mere decade. Remember, America will be looked on as a pariah by global lenders, particularly if we have defaulted on them via inflation. They might still lend to us if we have extremely appealing ideas — and a workforce to implement those ideas more cheaply than they could be done in, say, India or Thailand. This implies a cut in our standard of living that is almost beyond imagining. Not that it can’t happen, only that it would probably take a lot longer than a decade for the U.S. to become globally competitive in manufacturing. Unlike China, we would not have much of a domestic economy to sell into, and so our economy would initially be based mainly on exports. Can we actually do that? The answer had better be yes, or most Americans will be living in relative poverty for generations to come.

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Saving America

We don’t have any easy answers, but we’re hoping to hear from readers with ideas about how to return the U.S. economy to health. The person who submits the best essay on the topic What Will Save America will receive not only a scholarship to the Hidden Pivot seminar, but also unlimited access to post-graduate tutorial sessions held each week during market hours. The value of this package is $1,150, and a week into the competition we’ve received no fewer than 21 submissions, including one that argues that Americans need, more than anything else, to get serious about diet and exercise.

Essays should be 750 words or less and must be received at this e-mail address by no later than July 15. For details about the Hidden Pivot seminar and comments from those who have taken it, click here.

Our own idea about how to save America is to become a global leader in energy. A solution that works for the whole world would be a triumph for Yankee know-how on a par with the invention of the automobile assembly line. To stimulate thought on this topic and others, we will be presenting occasional guest commentaries by people with backgrounds in science and engineering. Economists need not apply. In the meantime, we welcome any contributions at the e-mail address linked above. We’ll print the best of them once the competition has concluded next month.

Over the weekend, I posted a link to a Chicago Tribune article with a deflationary subtext about how Americans have been cutting back on lattes and sundry other small pleasures. I copied a few pen-pals on this, including Mish Shedlock, Jas Jain, Bob Bronson and iTulip founder Eric Janszen, the only inflationist in the group. In the e-mail donnybrook that followed, Eric exhausted Mish’s patience with his standard schpiel, so in tag-team fashion, I took over for Mish. Immediately below, for your interest, are salient excerpts from the exchange I had with Eric. Please note that the dialogue is not entirely sequential, since all of my comments followed Eric’s last e-mail. I have posed some questions below that he therefore has not had a chance to answer. Nor will I provide him with the opportunity to do so in this space, since my debates with Eric have a way of running on forever. I have given myself the last word — I hope without having edited Eric too punitively. I have also generously embedded links wherever Eric sought to buttress his argument with previously published material.

The discussion begins with my rebuke to his notion that Japanese gold bugs fared poorly during Japan’s long deflationary wallow.

Gold in Japan

Rick: Better you should ask how the yen performed relative to all other classes of yen assets. Answer: Just fine. Gold in fact has always done relatively well as an investable during deflationary times. Still, as a hard-core deflationist, I have my doubts that the POG will get to Sinclair�s promised land above $5000 oz.

Eric: The yen performed well because the yen is not a reserve currency, the Japanese experienced a hyperinflation after the war, so protecting the yen was more important than preventing deflation. In contrast, the Fed is throwing the dollar under the bus to prevent deflation.

Rick: You’ve used a devious verb tense here, Eric: “is throwing.” In fact, the Fed has already thrown more than $1 trillion at the problem without succeeeding at inflating much of anything other than consumables.

Eric: Please take another look at the Argentina example. The relationship between the dollar and gold now for the US is similar to the relationship between the peso and the dollar for Argentina in the late 1980s.

Argentina ‘Irrelevant’

Rick: Argentina’s relevance is zero. The world’s investment assets — currently deflating like a hot air balloon hit by a Howitzer shell – were never priced in pesos.

Eric: Deflation in domestic peso terms, yes, inflation in dollar terms, yes also. Today US wage rates are 50% cheaper in euro terms than a few years ago — great if you are a European company paying employees in the US. Asset prices are falling in

dollar terms but crashing in euro terms; US real estate is wildly cheap if you are a European. Wage rates increased in Argentina during their inflation but an American company could buy labor in Argentina for pennies on the dollar. US wages are deflating against commodities priced in dollars, and domestic commodity prices, to the extent that these are determined by imports, are continuing to inflate.

Rick: To ask this question for perhaps the sixth or seventh time, how long can prices for imports continue to rise if Americans can no longer afford to buy stuff? In any event, where do you see this trend leading? Concerning wage deflation, no argument from me. Do I now infer that the only thing needed to bring you into the deflation camp is falling prices? That’s surely happening in residential real estate. Or do you perhaps believe that that component of deflation is isolated and will spread no further?

Eric: Oil not gold is the ultimate money as it is the critical input to everything else.

Rick: Agreed, that oil is even better than gold right now as the coin of the realm. But I suspect that the marginal demand for oil, now that it’s above $130/barrel, is falling at rates significantly higher than the 2% figure you’ve cited below — enough, I would warrant, to bring about a global economic collapse. That would be deflationary in the extreme, of course, and the effect would be epochally exacerbated by the throttling of recycled petrodollars.

Eric: Everything is deflating against oil. This event is widely misunderstood as a demand shock. Oil demand in OECD nations has declined to 2% annual growth since 2004 as oil prices doubled then doubled again. As China and oil producers are starting to reduce subsidies, demand will fall some more… we’ll see how long the oil kelptocracies and Chinese totalitarian state continue with that program — government give-aways is all they have to maintain political legitimacy. Meanwhile, producers have demonstrated that they intend to keep more of the oil they have left in the ground, so in spite of politically motivated assertions to the contrary they are not increasing supply but cutting it faster than demand is falling. This is, of course, inflationary. We call it Peak Cheap Oil.

Rick: I have no qualms about assuring my subscribers that Gold is all but certain to hold its purchasing power –­ not only relative to all other classes of assets, but relative to anything that you would care to call money.

Gold at $1,500?

Eric: Gold is an international currency. As governments print to reflate economies, the value of their currencies deflate against gold. My theory since 2001 is that this process will eventually take gold to $2500. Needless to say, that was contrarian back when gold was trading at $270. At $900 we have new entrants with very deep pockets to take us to the next stage of the market: ‘Gold prices may rise to $5,000 an ounce as investors seek to protect themselves against accelerating inflation, said Schroder Investment Management Ltd., which oversees $277 billion of assets globally.” [Click here for link].

Rick: I’ve never felt completely confident predicting $5000 gold in a world that will be quite broke. Also, I am mystified as to why gold has not already soared above $1,000. It’s not as though anyone believes Paulson or Bernanke when they talk up the dollar. Anyway, China’s currency will be ascendant when the world emerges from the coming Depression, and by then the Chinese will have no more need for official gold than Europe or U.S. have had in several generations.

Eric: If funds keep throwing billions at the gold market, and CBs become net buyers, who knows maybe we’ll get to $5000. The paradox is that they guys who created this mess are the same guys who are now struggling to maintain the purchasing power of all the money they made. The rest of us are collateral damage.

C-Note = $1 Bill

Rick: Even more certain is that, on a day in the not-too-distant future, Americans will realize that the hundred dollar bills they carry in their wallets are fundamentally and intrinsically worth no more or less than the $1 bills. I can�t tell from your writing whether you understand this, but if you do, it should disabuse you of the notion that the economy is somehow going to continue to muddle along. Muddling is one thing we deflationists all strongly agree cannot continue for much longer.

Eric: I have no illusions that the US economy can muddle along. For a quick summary of my positions, I recommend: [click here for link to USA, Inc. Common Shares: Long or Short? ; here for link to A Financial Market Crash is a Process, Not an Event ; and here for The Myth of the Slow Crash]

Rick: Concerning deflation and its symptoms, there is little I would care to add to the story I linked from the Chicago Tribune (which you have yet to acknowledge and presumably did not bother to read). When middle-class America cuts out

lattes and starts refilling soda-pop containers, that is not inflation, or stagflation, or hyperinflation; it is a small step toward Depression, when almost nothing pleasurable, or that we currently take for granted, will be affordable.

Eric: I did read it. Substitution always occurs during inflations. See [click here for link].

Tomorrow: Part 2, in which Eric at long last states succinctly what he expects to happen, and what he means by ‘inflation.’ His endgame scenario is not at all implausible, but neither is it so very logical and compelling that it deserves to go unchallenged.

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Saving America

We don’t have any easy answers, but we’re hoping to hear from readers with ideas about how to return the U.S. economy to health. The person who submits the best essay on the topic What Will Save America will receive not only a scholarship to the Hidden Pivot seminar, but also unlimited access to post-graduate tutorial sessions held each week during market hours. The value of this package is $1,150, and just two days into the competition we’ve received no fewer than four submissions, including one today that argues that Americans need, more than anything else, to get serious about diet and exercise.

Essays should be 750 words or less and must be received at this e-mail address by no later than July 15. For details about the Hidden Pivot seminar and comments from those who have taken it, click here.

[Insert photo here]

Our own idea about how to save America is to become a global leader in energy. A solution that works for the whole world would be a triumph for Yankee know-how on a par with the invention of the automobile assembly line. To stimulate thought on this topic and others, we will be presenting occasional guest commentaries by people with backgrounds in science and engineering. Economists need not apply. In the meantime, we welcome any contributions at the e-mail address linked above. We’ll print the best of them once the competition has concluded next month.

Short sellers on the New York Stock Exchange set a new record in the first half of June, amassing a total position of 17.6 billion shares. If that sounds impressive or even especially bearish, don’t be fooled. In theory, at least, every one of those shares could have been shorted by traders and investors who are quite bullish on stocks. Actually, most short positions are initiated not by bears, but by institutions and floor traders seeking to extract profits from essentially riskless hedge positions. Two hedges commonly used are ‘conversions’ and ‘reverse conversions.’

Let’s take a ‘reversal’ in Google as an example. With the stock currently trading $548 per share, you could lock in the three-sided reversal by shorting 100 shares of stock, shorting a September 550 put for $40 and buying a September 550 call for $39. If you work the numbers, you’ll see that no matter what price Google is trading on September 19, when the options expire, your nominal loss on the position would be $100. Let’s assume the stock is trading for exactly as much then as it is now, $548. You would have no gain or loss on the stock, but the put that you’d shorted for $40 (i.e., $4,000) would be worth $2 (i.e., $200), since the option would be $2 in-the-money. Your net gain from the sale of the short put would therefore be $3,800. But the call for which you had paid $39 (i.e., $3,900) would be worthless, so you would have lost that entire amount. Your net loss on the three-sided position, then, would be $100. If you were to work the numbers with Google trading for, say, $485 come September 19, you’d find that your net loss would still be $100.

So why would anyone want to use such a strategy, locking in a certain loss ‘in this case, of $100? Answer: To generate interest income on the short stock. Remember, the position is essentially riskless no matter what happens to the stock, and you took in $54,800 of someone else’s money when you sold 100 shares short at the outset. If you had invested that money in risk-free paper at the current Libor rate of 2.40%, you would have reaped interest income of about $350 over the three-month life of the options. Your net gain on the position would therefore be $250, equal to $350 in interest income less the $100 position loss. That would be further reduced by the amount of any dividends paid by Google during the period, since those dividends would come out of your pocket. But because Google pays no dividend, the entire $250 of interest income would be yours to keep. Not bad, considering you used someone else’s money to make that money.

Betting on a Crash

And that’s why we shouldn’t get too excited about short interest figures, even when they soar to new record highs. To be sure, bearish bettors will have stepped up their short selling lately, given that the U.S. economy and stock market are more vulnerable to a crash than at any time since 1929. Moreover, those betting that the market is headed for a fall are bound to cause breathtaking short-covering rallies as the bear market intensifies over the next several years. But there is nothing significant per se about the fact that total short interest is nearly 18 billion shares. Nor should we be surprised to see that number climb as hedgers and arbitrageurs increasingly dominate the action on the NYSE and other exchanges. There are no longer any long-term investors in the game, the game itself having become little more than an interest-rate play.

Like the put-and-call ratio, short interest is just one more number whose fundamental significance lies beyond the understanding of those traders, investors and technical analysts who would seek to profit from such data. In practice, we can tell far more about the significance of short selling, whatever its extent, by simply watching for signs of nervous buying at the beginning and end of each trading day

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Saving America

We don’t have any easy answers, but we’re hoping to hear from readers with ideas about how to return the U.S. economy to health. The person who submits the best essay on the topic What Will Save America will receive not only a scholarship to the Hidden Pivot seminar, but also unlimited access to post-graduate tutorial sessions held each week during market hours. The value of this package is $1,150, and just two days into the competition we’ve received no fewer than four submissions, including one today that argues that Americans need, more than anything else, to get serious about diet and exercise.

Essays should be 750 words or less and must be received at this e-mail address by no later than July 15. For details about the Hidden Pivot seminar and comments from those who have taken it, click here.

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Our own idea about how to save America is to become a global leader in energy. A solution that works for the whole world would be a triumph for Yankee know-how on a par with the invention of the automobile assembly line. To stimulate thought on this topic and others, we will be presenting occasional guest commentaries by people with backgrounds in science and engineering. Economists need not apply. In the meantime, we welcome any contributions at the e-mail address linked above. We’ll print the best of them once the competition has concluded next month.

We don’t have any easy answers, but we’re hoping to hear from readers with ideas about how to return the U.S. economy to health. The person who submits the best essay on the topic What Will Save America will receive not only a scholarship to the Hidden Pivot seminar, but also unlimited access to post-graduate tutorial sessions held each week during market hours. The value of this package is $1,150, and just two days into the competition we’ve received no fewer than four submissions, including one today that argues that Americans need, more than anything else, to get serious about diet and exercise.

Essays should be 750 words or less and must be received at this e-mail address by no later than July 15. For details about the Hidden Pivot seminar and comments from those who have taken it, click here.

Our own idea about how to save America is to become a global leader in energy. A solution that works for the whole world would be a triumph for Yankee know-how on a par with the invention of the automobile assembly line. To stimulate thought on this topic and others, we will be presenting occasional guest commentaries by people with backgrounds in science and engineering. Economists need not apply. In the meantime, we welcome any contributions at the e-mail address linked above. We’ll print the best of them once the competition has concluded next month.

With residential building in a state of near-collapse, we tend to think that the construction business in general is depressed. While this largely true, there are evidently some niches within the industry that are doing quite well. This point was driven home yesterday in the Rick’s Picks chat room by a commercial builder and subscriber, John D., who occasionally drops in during trading hours. He bore news that Ainsworth, the largest wood panel supplier in America, was on the ropes because of the depressed housing market. Bondholders have taken over the company’s day-to-day operations at the request of the family that has owned and operated Ainsworth.

John’s firm has been feeling the pressure of recession as well. Profits are down and margins are tight ‘ ‘just like on Wall Street’ — and three large projects in which the company was involved have been put on hold due either to the lack of a tenant or of financing. Even so, he notes, there is construction business to be had if you can provide certain specialized services. Such as? In the case of John’s firm, the services include retrofitting structures so that they can use solar energy. ‘We are trying to hook up with solar companies to provide engineering and roof structure reinforcement for buildings,’ he notes. ‘It is a wide open market. Costco is going solar on many of its existing buildings, and structure reinforcement is an emerging market.’

John says that many big-box retailers besides Costco are ‘going solar,’ and that this has driven him to try and market his firm’s services nationally. But such projects take considerable know-how. Most existing structures cannot handle the additional loads that solar panels add, John explains, and the engineering is not simple. ‘A good engineer can save big bucks on the reinforcement of the structure, but there are only a few engineers who can do this work, especially on the steel-bar joist. We are one of them and are in the loop with the number one [solar] guy.’

Holding Down Costs

‘An engineer who knows what he is doing is able to keep the reinforcement to a minimum,’ John continued, ‘but if he does not, then the cost can get out of hand in a hurry. We just completed a Toys R Us. It was not for solar, but they were moving into a building that was not designed for what they wanted to hang from the structure. They could not find anyone to engineer and do the work. We teamed up with an engineer we know and completed the job in two weeks, including engineering. No one else could do this.’

John thinks solar work is likely to continue to receive tax credits over the next several years. If so, the continuing success of his business could be a bright spot in a generally depressed industry. Whatever happens, we wish him well as his firm finds ways to stay on the cutting edge in these very challenging times.

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Win a $1,000 Scholarship!

Has the Hidden Pivot Seminar’s $990 cost been the main obstacle to your taking the course? Fret not, because everyone who reads or subscribes to Rick’s Picks will have a chance to win a full scholarship ‘ not only to the seminar, but to an unlimited number of post-graduate tutorial sessions that are offered regularly during market hours. The package is worth $1,150 but it can be yours for free if you produce the most interesting essay on this topic: What Will Save America. Submissions should be no longer than 750 words and must be received at this e-mail address by no later than July 15. For details about the seminar itself and comments from those who have taken the course, click here.