Fear Trade Back? Sergey Aleynikov & HFTs, Goldman's Trading Scandal, 2nd Stimulus, U.S. Office Market Collapse

News that Moves Markets

with RCM Editorial

On Monday I revealed long term trends that, as I said, must be respected. However, today I wish to offer a thought that may help those who wish to trade on a shorter time frame. Government manipulation, with the help of big investment banks, has turned shorter term decision making into a sort of black art form. Many traditional short term traders are becoming increasingly frustrated and chewed up by the seemingly incongruous volatility. Traditional decision making factors e.g. EPS news, technical analysis readings, other company fundamentals, have taken a back seat in the short term, say 3-4 months, to government desired outcomes. It's a brand new world so you must use new tools. Consider this:

The Government felt the need to recapitalize banks in March. So, with the help of GS/JPM and others the manipulation game began to rally the market. "Helicopter" Ben began talking about "green shoots", government statistics "surprisingly" began to look better, and GS proprietary traders made a fortune on the rally because they are just sooo good. Result: A 3 1/2 month equity market rally that led to massive capital raise for the financial space through major secondary offering. GS raised billions with a secondary priced @ $123 up from the Nov. low of $47.41.

However, the equity market rally resulted in a Treasury bond market sell-off and a disturbing hike in interest rates. The "Helicopter" and "Pinocchio" know that rates going up will kill any hope of economic recovery. So, now that suckers have invested billions in the financial space the focus has shifted to supporting the bond market at a time when issuance of new Treasury debt is exploding. Possible Result: Expect an equity market sell-off over the next few months to help support the Treasury bond market and keep yields down. The fear trade is back in vogue.

One more thought, the arrest of Sergey Aleynikov may not be getting the press coverage it deserves. High-frequency trading (HFT) platforms are a major Achilles heel of this market. Joe Saluzzi of Themis Trading wrote a phenomenal piece about HFT that I covered in my July 1st post. Take the time to re read this post to fully comprehend the dangers.

Bloomberg: Goldman May Lose Millions From Ex-Worker’s Code Theft

...At a court appearance July 4 in Manhattan, Assistant U.S. Attorney Joseph Facciponti told a federal judge that "...The bank (GS) has raised the possibility that there is a danger that somebody who knew how to use this program could use it to manipulate markets in unfair ways,” When I read this I almost fell off my chair. What a blunder by Goldman. In other words, GS uses the code to manipulate markets but in a fair way? Who determines what is fair? Drop the debate of fair or unfair and you can see that GS admits to manipulating the markets! Read more...

Zero Hedge covers this story with the respect it deserves: Is A Case Of Quant Trading Sabotage About To Destroy Goldman Sachs?
Posted by Tyler Durden

We must follow this story closely because program trades now account for about 50% of the volume on the NYSE and if the HFT model somehow grinds to a halt liquidity will plummet potentially wrecking havoc on prices. For more read the A Goldman trading scandal?

And the beat gets louder...
U.S. should plan 2nd fiscal stimulus: Economic adviser - Reuters
Reuters reports the U.S. should be planning for a possible second round of fiscal stimulus to further prop up the economy after the $787 bln rescue package launched in February, an adviser to President Barack Obama said. "We should be planning on a contingency basis for a second round of stimulus," Laura D'Andrea Tyson, a member of the panel advising President Barack Obama on tackling the economic crisis. said on Tuesday. Addressing a seminar in Singapore, Tyson said she felt the first round of stimulus aimed to prop up the economy had been slightly smaller than she would have liked and that a possible second round should be directed at infrastructure investment. "The stimulus is performing close to expectations but not in timing," Tyson said, referring to the slow pace at which the first round of stimulus had been spent on the economy.

Reality vs. "Green Shoot"...
U.S. office market continues to spiral down - Reuters.com
Reuters.com reports the U.S. office market vacancy rate reached 15.9% in Q2, its highest in four years and rent fell by the largest amount in more than seven as demand from companies and other office renters remained weak, real estate research co Reis said. "It's bad," Reis director of research Victor Calanog said. "It's decaying and getting worse. Given the depth and magnitude of the recession, you can argue that we are facing a storm of epic proportions and we're only at the beginning. The weak demand helped push up the average weighted U.S. office vacancy rate 0.70 percentage points during the quarter and 2.7 percentage points compared with a year ago, according to the report released. Asking rent during the quarter fell 1.4% to $28.43 per square foot. Factoring in rent-free months and improvement costs to landlords, effective rent fell 2.7% in the quarter to $23.42 per square foot. The second-quarter drop was more severe than the first quarter's 2.3%, dampening hopes the office market is bottoming out, Reis said. Year over year, rent was down 6.7%, the largest one- quarter decline since the first quarter 2002. "This is really only the third quarter that we've experienced negative effective rent growth," Calanog said. "Last time, the office sector had four years of negative effective rent growth."

Manipulation of Equity Markets: Helicopter Ben, Pinocchio Tim and Arthur Levitt / California Misses Budget Deadline

RCM Editorial

While the mainstream media is busy rolling "green shoots" and smoking them, I thought I'd compose a post today to help you 'JUST SAY NO.'

Ben "Helicopter" Bernanke and his side kick Tim "Pinocchio" Geithner (honestly, watch him speak, I swear his nose looks like it grows) have been dealing some pretty potent D.C. "trip shoots." Of course, they are not alone. A vast network of dealers have combined to create the hallucinogenic state in which the mainstream media floats.

Perhaps the most dastardly dealers in the cartel are those who manipulate the equity markets. They claim to be champions of the free markets and providers of liquidity when they are anything but. They team up with big brokerage firms who love the gravy train of fees and drive up the cost of doing business for the rest of us.

I'm going to take a leap so try and stay with me. If you would like someone to blame for the predicament we are in today look no further than Arthur Levitt. Levitt, an ex-head of the SEC and beloved blatherskite of news outlets everywhere, spearheaded the ruination of Wall Street with the move to decimalization. In his infant wisdom, he believed that the spreads between the bid and ask on equities were too large and therefore hurt the small investor. His stupidity prevented him from realizing that spreads were and are necessary to create real liquidity. As an investor I'd rather see a .25 cent spread on a stock and know I can trade real volume at the price than a .01 cent spread with no volume. In today's market of decimalization an investor may have to bid a stock (all but the most liquid) up $1 or more to find the real volume that would have been there a 1/2 point lower in a spread environment.

The advent of decimalization murdered a major profit center for the brokers and forced them to find other means of revenue. We all know how that worked out. The profit center of spreads for brokers was not a gift. It was earned by way of creating real liquidity. Decimalization has led to a serious disease of manipulation in the markets today. The blog post below by Joe Saluzzi and the clip from CNBC should further illuminate this argument:

Joe Saluzzi Themis Trading:

Our equity market is being controlled by machines that are nothing more than two bit, SOES bandits. They cloak themselves under the mantra of liquidity providers but they are really just locusts and are feeding off the equity market until it doesn’t suit them anymore. Once their profit margins are squeezed to almost zero, they are likely just to move on to a new market. But what damage would they have done? We will be left with a shell of a market that is used to being led around by computers. Real people and real capital are a scarce resource in today’s market. Read more...

And Here It Is On CNBC: Manipulation

(I'd like to take this moment to commend Rick Santelli whose voice is a true beacon of light on this otherwise wasteland of a network.)

RCM Comment: This California story is not getting much news coverage but should be on the top your watch list. California's slow sinking into the financial abyss could destabilize the credit markets and in turn the equity markets...

California misses budget deadline, readies "IOUs" - Reuters.com :

Reuters.com reports California's lawmakers failed to agree on a balanced budget by the start of its new fiscal year on Wednesday morning, clearing the way to suspend payments owed to the state's vendors and local agencies, who instead will get "IOU" notes promising payment. The notes will mark the first time in 17 years the most populous U.S. state's government will have to resort to the unusual and dramatic measure. Democrats who control the legislature could not convince Republicans late on Tuesday night to back their plans to tackle a $24.3 billion budget shortfall or a stopgap effort to ward off the IOUs. The two sides agree on the need for spending cuts but are split over whether to raise taxes. Democrats have pushed for new revenues while Republican lawmakers and Governor Arnold Schwarzenegger, also a Republican, have ruled out tax increases. They instead see deep spending cuts as the solution to balancing the budget, but Democrats say that would slash the state's safety net for the needy to the bone.

IBD Cartoon, Obama, Chavez, Ortega, Castro

RCM Editorial

I posted yesterday a rather uplifting story about the Honduran's protecting their Constitution and deposing a dictator. The dictator, conveniently disguised as a president, wanted to abolish term limits so he could rule the country like Hugo. No matter what your political leanings, right, left or center, there is no way to argue that this power grab is anything other than undemocratic and unconstitutional.

Now I ask you, why would our president, the leader of the supposed free world, condemn the actions of a people trying to remain free and protect democracy and a constitution?

Would it be perhaps because our president is presiding over a government that is stepping all over our constitutional rights and those actions have clouded his judgement? Or is it something altogether more disturbing? Has this country elected a president who does not respect term limits; one who does not believe in a true democracy but instead a type of socialism?

Take a close look at this cartoon from the Investors Business Daily today. It is more tragic than funny and closer to reality than you may want to admit.

Coping with Government Sponsored Market Manipulation

RCM EDITORIAL

RCM Comment: We live in a world where markets are manipulated by governments. To argue this point is to howl at the moon. We are not conspiracy theorists; we are realists. In order to successfully manage a portfolio in this environment one must understand the playing field and the rules. There is no point in complaining about the manipulation or pointing fingers. This type of behavior is an exercise in futility. No, we must accept the situation and turn it to our advantage.

We must recognize that markets are not free to trade and therefore do not react as we would expect to certain news events. Sometimes this manipulation is a good thing. Take for example the market reaction to 9/11. After being closed for four days the equity markets surged higher with the help of massive PPT buying of S&P futures contracts. Unfortunately, governments tend to bastardize a good thing and we are now faced with a market that is rigged to suit government needs in the short term. However, you can rest assured that true market direction will prevail over the longer term.

So, our struggle is to understand the long term view but not allow the government manipulated markets to cut up our capital in the short term. We must not allow the government manipulations to cloud our judgement and sucker us into investments that have no hope of success over time. Example: the government-sponsored rally in the financials over the last 3+ months was clearly created to help the banking sector raise capital. Again, if you wish to argue this point I suggest you go down to the water's edge and scream at the tide. Massive amounts of capital were raised through the secondary markets for financial companies in the last 30 days. This is a simple fact. Now that this manipulation is complete and private capital has been sucked in where will the equity markets go? Only time will tell, but I will offer this thought process:

The economy is not in good shape.

The Fed must work to keep rates low.

The stock and bond markets have been trading in opposite directions for months.

Therefore, if the Fed focuses on supporting the bond market going forward then the equity markets may be in for trouble.

The economy is not in good shape: Proof

The weekly Railfax Rail Carloading Report still looks grim. A report from the real world

Moody's: "Sellers Beginning To Capitulate To Realities Of CRE Markets."

Moody's has released its April Moody's/REAL Commercial Property Price Indices (CPPI) update and it is a doozy: -8.6%, after what many had expected was a shooting green reading of just -1.7% in March. The problem that many don't grasp, that even Moody's has finally caught on, is that once capitulation in CRE sets in, the bottom will be torn out. Read more...

Redbook Retail Index Plunges Again

The Johnson Redbook Index is a sales-weighted year-over-year same-store sales growth in a sample of large US general merchandise retailers representing about 9,000 stores. Same-store sales are sales in stores continuously open for 12 months or longer. Read more...

I have included the story below simply for your own edification. The explanation below illustrates how the manipulation works and I hope it helps you understand and cope with seemingly incongruous market volatility.

Market Skeptics.com: Understanding the PPT and market manipulation

The PPT operation has access to unlimited funds because it was formed by the Treasury which can create money out of thin air. My guess is that the organization is structured through an offshore hedge fund established by the ESF as a front group. They do their buying and selling from perhaps the Bahamas or the Cayman Islands.

One thing we know is that they place their orders through several of the big brokerages in New York such as Goldman Sachs, JP Morgan, or Merrill Lynch. This way no one at the brokerage houses or on the exchange floors actually sees any massive buy orders from Washington bureaucracies.

The way they work the scheme is whenever the market is going too low and threatening to crash, the PPT initiates buy programs on margin for S&P futures contracts in large enough volume to check the market fall and panic short sellers into covering their short positions. This creates a "short squeeze" and explodes prices upward. Hedge funds and institutional buyers then rush into the market to buy in order to catch the rally. This extends the rally and effectively ends the potential market crash as investor mood shifts from bearish to bullish.

The rally is created in the way that lighting a match to kindling ignites a roaring fire. The S&P futures contracts are so highly leveraged that a $200 million buy can be initiated for $10 million in the PPT account with JP Morgan. A $500 million buy can be initiated for $25 million. These margins are chump change for the Treasury-ESF(Exchange Stabilization Fund)-PPT(Plunge Protection Team) operatives. As the rally proceeds, the PPT then sells their contracts back to the hedge funds and institutional buyers that follow after them. The PPT then goes to the sidelines to await the next crisis when they will need to stem a potential crash.

RCM Editorial: Democratic Lawmakers Urge Reduction in Lending Standards / Barney the Dino Strikes Again

RCM Comment: We here at RCM have uncovered the mystery behind the housing troubles in the U.S. We have heard countless explanations and witnessed our colleagues struggle with the conundrum. Well, the super sleuths that we are, we have leaped the why in a single bound and here it is, get ready... "Barney Frank, the Massachusetts Democrat, is chairman of the House Financial Services Committee":

Changes urged to rules on condo loans - WSJ
Democratic lawmakers are calling on Fannie Mae (FNM) and Freddie Mac (FRE) to relax recently tightened standards for mortgages on new condominiums, saying they could threaten the viability of some developments and slow the housing-market recovery. In March, Fannie Mae said it would no longer guarantee mortgages on condos in buildings where fewer than 70% of the units have been sold, up from 51%. Fannie Mae also won't purchase mortgages in buildings where 15% of owners are delinquent on condo association dues or where one owner has more than 10% of units, which the firm sees as signals that a building could run into financial trouble. Freddie Mac will implement similar policies next month. In a letter to the chief executives of Fannie and Freddie, Reps. Barney Frank, the Massachusetts Democrat who is chairman of the House Financial Services Committee, and Anthony Weiner (D., N.Y.) warned that the 70% sales threshold "may be too onerous" and could lead condo buyers to shun new developments. (Isn't that the point? New developments that are shaky need to stop so all the supply from overbuilding can come back into equilibrium with demand.) The legislators asked the companies to "make appropriate adjustments" to their underwriting standards for condos.

RCM Comment: Once again Barney illustrates his complete ignorance, stupidity, philistinism (Click here to continue the cathartic release) with regard to anything resembling sound economics. Has Barney learned nothing from the crisis? Last year I watched him accuse Fannie and Freddie of the very same weak lending practices he is now championing. We ask: Can anyone be this obtuse? What's the hidden agenda? Will we find out Barney stands to benefit financially if condo communities are artificially inflated?

Let's not forget that Freddie and Fannie are bankrupt entities. Any reduction in lending standards will likely lead to another trillion of losses. Who will pay for that? The American tax payer. Thanks Barney! Sixty-four thousand dollar question: When will Barney's constituents wake up and vote him out of office?

RCM Editorial: US$/US T-Bonds/Gold, The Con. Game In Quotes

RCM Comment: As readers you may recall in March we advised shorting the US$ and US Treasury Bonds while maintaining and/or building a long position in Gold. We believed (and rightfully so) that the $300 billion quantitative easing announcement by the Fed would have negative implications for the US$ and Bonds. However, over the last week or so we have seen a bit of a correction across the board with regard to this trade. The usual nest of neophytes rush to extol the virtues of the US$, the strength of the Fed chairman and the ensuing economic recovery, all the while deriding the value of Gold.

Rest assured, we have not changed our outlook. We will from time to time use extremes to add to or reduce positions as we deem necessary. This behavior is simply prudent portfolio management but our primary convictions are not swayed by Government or Fed comments, which are notoriously misleading. In fact, I have a running debate with a colleague who seems determined to drink the Kool-Aid the Fed chairmen and treasury secretary are serving. He quotes testimony as if it's gospel and I fear for his portfolio safety.

To that end, I am publishing the following two stories in the hopes the information will snap him out of the Bernanke mind meld and the Geithner hypnosis.

From Prvt'r..June 14
IN THE LAST DITCH ON THE US DOLLAR FRONT

The US Dollar’s position as the world’s reserve currency isn’t under threat. Our trust in US Treasuries is absolutely unshakable.” - Japanese Finance Minister Kaoru Yosano - June 10, '09

(Russia) “does not see any changes in our policy with regards to dollar-denominated paper over the next year or more.” - Russian Finance Minister Alexei Kudrin - June 12, 2009

German Finance Minister Peer Steinbrueck was reported to “not be concerned” with
the Euro’s value against the US Dollar

IMF Managing Director Dominique Strauss-Kahn “doesn’t see a weak US Dollar”.

We must invoke here nineteenth century German Chancellor Otto von Bismark’s “law” - “Never believe anything in politics until it has been officially denied three times”. There’s four for you, and there were undoubtedly many more during the G-8 Finance Ministers’ meeting in Italy.

RCM Comment: The US$ has gained strength on these stories. Does the fable of the fox and the gingerbread boy ring any bells?

The Confidence Game In Quotes: Courtesy of the Austrian Filter

February 28, 2007 - Dow Jones @ 12,268

March 13th, 2007 – Henry Paulson: “the fallout in subprime mortgages is "going to be painful to some lenders, but it is largely contained."

March 28th, 2007 – Ben Bernanke: "At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained,"

March 30, 2007 - Dow Jones @ 12,354

April 20th, 2007 – Paulson: "I don't see (subprime mortgage market troubles) imposing a serious problem. I think it's going to be largely contained." , "All the signs I look at" show "the housing market is at or near the bottom,"

April 30, 2007 - Dow Jones @ 13,063

May 17th, 2007 – Bernanke: “While rising delinquencies and foreclosures will continue to weigh heavily on the housing market this year, it will not cripple the U.S.”

May 31, 2007 - Dow Jones @ 13,627

June 20th, 2007 – Bernanke: (the subprime fallout) ``will not affect the economy overall.''

October 15th, 2007 – Bernanke: "It is not the responsibility of the Federal Reserve - nor would it be appropriate - to protect lenders and investors from the consequences of their financial decisions."

December 31, 2007 - Dow Jones @ 13,265

January 31, 2008 - Dow Jones @ 12,650

February 14th, 2008 – Paulson: (the economy) "is fundamentally strong, diverse and resilient."

February 28th, 2008 – Paulson: "I'm seeing a series of ideas suggested involving major government intervention in the housing market, and these things are usually presented or sold as a way of helping homeowners stay in their homes. Then when you look at them more carefully what they really amount to is a bailout for financial institutions or Wall Street."

February 29th, 2008 – Bernanke: "I expect there will be some failures. I don't anticipate any serious problems of that sort among the large internationally active banks that make up a very substantial part of our banking system."

March 16th, 2008 – Paulson: "We've got strong financial institutions . . . Our markets are the envy of the world. They're resilient, they're...innovative, they're flexible. I think we move very quickly to address situations in this country, and, as I said, our financial institutions are strong."

March 18th, 2008 - Bear Stearns Bailout Announced

May 7, 2008 – Paulson: 'The worst is likely to be behind us,”

May 16th, 2008 – Paulson: "In my judgment, we are closer to the end of the market turmoil than the beginning," he said.

May 30, 2008 - Dow Jones @ 12,638

June 9th, 2008 – Bernanke: Despite a recent spike in the nation's unemployment rate, the danger that the economy has fallen into a "substantial downturn" appears to have waned,

July 16th, 2008 – Bernanke: (Freddie and Fannie) “…will make it through the storm”, "… in no danger of failing.","…adequately capitalized"

July 20th, 2008 – Paulson: "it's a safe banking system, a sound banking system. Our regulators are on top of it. This is a very manageable situation."

July 31, 2008 - Dow Jones @ 11,378

August 10th, 2008 – Paulson: ``We have no plans to insert money into either of those two institutions.” (Fannie Mae and Freddie Mac)

September 8th, 2008 - Fannie and Freddie nationalized. The taxpayer is on the hook for an estimated 1 - 1.5 trillion dollars. Over 5 trillion is added to the nation’s balance sheet.

September 16th, 2008 - $85 Billion AIG Bailout “Loan”

September 19th, 2008 - $700 Billion Bailout Plan Announced

September 19th, 2008 – Paulson: "We're talking hundreds of billions of dollars - this needs to be big enough to make a real difference and get at the heart of the problem," he said. "This is the way we stabilize the system."

September 19th, 2008 - Bernanke: "most severe financial crisis" in the post-World War II era. Investment banks are seeing "tremendous runs on their cash," Bernanke said. "Without action, they will fail soon."

September 21st, 2008 – Paulson: "The credit markets are still very fragile right now and frozen", "We need to deal with this and deal with it quickly.", "The financial security of all Americans ... depends on our ability to restore our financial institutions to a sound footing."

September 23rd, 2008 – Paulson: "We must [enact a program quickly] in order to avoid a continuing series of financial institution failures and frozen credit markets that threaten American families' financial well-being, the viability of businesses, both small and large, and the very health of our economy,"

September 23rd, 2008 – Bernanke: "My interest is solely for the strength and recovery of the U.S. economy,"

October 31, 2008 - Dow Jones @ 9,337

March 31, 2009 - Dow Jones @ 7,609

RCM Editorial: Should Ben Bernanke Be Reappointed? And Other Questions on Bloomberg TV's, 'No Visibility Ahead'

RCM Comment: Today on Bloomberg TV a promotion is running urging viewers to watch the 7:00 pm show, No Visibility Ahead: Predicting What's Next, during which a moderator will question a panel about the current economic situation and the credit crisis. This panel will include the likes of Jack Welch and Meredith Whitney. I imagine this will be an interesting forum, however, in the promo the group dances around a key question and since they are unwilling to give a straight answer I will jump into the breach. Admittedly, it is easier for me to voice my opinion in this post than on national TV, but I hope I would have the integrity and moxie to answer this question on any medium.

The question: Should Ben Bernanke be reappointed to Fed chairman when his term is up?

While others dance I will stand like a Rodin and say emphatically, NO. Those of you who have been reading this blog for the last few years and/or have spoken with me know that since Ben took over as chairman we have been concerned. We contended that an academic who was known as "Helicopter Ben" was a perilous appointment. We voiced our concern when Ben decided, in March of 2006, to stop the government's reporting of M3. We took this as a clear sign of Ben's willingness to devalue the US$ and we launched our Fortune's Favor Precious Metals fund in August of 2006 to benefit from this direction. During a time of rampant free credit Bush appointed a free credit junky. Many metaphors come to mind to describe the situation, but I think the arsonist and the fire will suffice.

If the desire is to further destroy the value of the US$, send treasury bond prices plummeting / rates soaring and lead us headlong into massive hyperinflation then by all means reappoint Ben Bernanke. As investors we welcome the continued policies of Ben as we have a clear road map to success through our commitment to Gold, Silver, energy and other commodities. But as patriots of this country and believers in the fundamentals established by Alexander Hamilton and our forefathers we urge the administration to appoint someone who will attempt to right the ship.

The following are a few stories that may shed some light on the effect of the current administration's policies as well as Ben's actions:

GMT:

The rising cost of insuring debt is impacting treasuries too. The cost to hedge against losses on $10 million of Treasuries is now about $100,000 annually for 10 years, up from $1,000 in the first half of 2007. These rising insurance costs have helped push up treasury yields in the last few months. Worse still, the rising costs of insuring against government defaults will undermine faith in dollar. After all, the CDS market is telling us that 10-year treasury notes have become 100 times riskier in the last two years.

Jim Sinclair:

Remember hyperinflation is NOT an economic event, it is a currency event.
If you study market history you will see the glaring truth that the Weimar experience would not have happened if German debt markets were not used as a vehicle to heavily short the Weimar Mark.

It was the Weimar mark short sellers that created the Weimar hyperinflation just as the OTC derivative shorts will cream the US dollar with the unavoidable effect being hyperinflation.
I know of what I speak. About the above there is no doubt. There is no real argument to the contrary and you can count the number of those outside of our community on one hand who understand how hyperinflation is created."

Dave from Denver on the real deal…
More fantasy housing numbers and prior revisions

New home sales were reported to be up .3% in April, HOWEVER, March numbers were revised from +.6% to -3%. That's a huge revision. MOREOVER, new home sales plunged 34% compared with a year ago.

More disturbing yet, Americans fell behind on their mortgages and foreclosures hit a record pace in the 4th quarter. Mortgage delinquencies hit 7.9% of all loans, the highest level since 1972. Prime delinquencies are now higher than subprime delinquencies. This statistic should completely terrify everyone, as the prime mortgage market is 10x the size of the subprime/alt-a market.

RCM Editorial: The Ramifications of Increasing US$ Weakness

RCM Comment: The US$ is breaking down again today and has taken out key support. I continue to write about this weakness because the ramifications of the continued demise of the US$ are far reaching. Allow me to list a few thoughts to keep in mind while we watch the US$ developments:

Weakness in the US$ goes hand in hand with an eventual rise in rates/fall in prices of US treasury bonds. A rise in rates is contrary to what the Fed wants and detrimental to the recovery process.

The Fed has pledged to buy $300 billion of US treasury debt. Since this announcement the US$ has weakened substantially as we predicted. The purpose of this buying spree is to keep rates down. However, printing the fresh $300 billion weakens the US$ in turn pushing up rates. I fear the Fed is caught in a vicious cycle.

This cycle has accelerated the desire of our key trading partners to diversify out of the US$ as discussed in the Brazil/China story below. This diversification is like a body of warm water that fuels a hurricane. Stories of diversification take the vicious cycle and turn it into a named storm.

In a strange twist, often weakening currency leads to rallying equity prices for a time as the investing public realizes that holding cash is counter productive. This equity rally does not mean "green shoots" are forming and is not sustainable long term. Trade the rally? Yes. Buy and hold it? No.

This behavior also leads to a rally in commodity prices, which results in a blowout of inflation. This is the sector to establish longer term holdings for a more significant move. Pay no attention to the talking heads who blather on about impending deflation. They are simply missing the big picture and are stuck in a quagmire of minutia. Inflation is a currency event not an economic event. Example: For weeks now these self-proclaimed "pundits" pound the table screaming that the world is awash with oil. They point to "huge" inventory numbers each week and argue that oil should be trading in the low $40s. However, much to their chagrin, oil continues to roll ahead and trades today over $61. Are they wrong about the inventory numbers? No, but it is oil's relationship with the US$ that is driving prices and this fact they either can't see or choose to ignore.

We need to watch for signs that this named storm, let's call it Ben, is picking up speed and act accordingly to protect our assets. The Privateer reports: "As of May 7, US Treasury 30-year bonds had lost investors 20.9 percent in 2009 according to Merrill Lynch & Co indexes, as the Treasury increases security sales to help fund a swelling budget deficit. The world is now paying more on US Treasury credit default swaps than McDonald’s does on its borrowings." This fact raises the level from tropical storm strength to category 1. The best weapon to protect our assets - the storm shutter to the window of our portfolio - is gold. Please hold on to the bar.

Brazil and China eye plan to axe dollar - Financial Times
Financial Times reports Brazil and China will work towards using their own currencies in trade transactions rather than the US dollar, according to Brazil's central bank and aides to Luiz Inacio Lula da Silva, Brazil's president. The move follows recent Chinese challenges to the status of the dollar as the world's leading international currency. An official at Brazil's central bank stressed that talks were at an early stage. He also said that what was under discussion was not a currency swap of the kind China recently agreed with Argentina and which the US had agreed with several countries, including Brazil. "Currency swaps are not necessarily trade related," the official said. "The funds can be drawn down for any use. What we are talking about now is Brazil paying for Chinese goods with reals and China paying for Brazilian goods with renminbi." Henrique Meirelles and Zhou Xiaochuan, governors of the two countries' central banks, were expected to meet soon to discuss the matter, the official said.

Fleckenstein on China / Brazil development:

For Silva and Hu, an FX "I Do"
The dollar declined about 0.75% -- though even more trouble is brewing for our green paper. For those who don't know, Presidents Luiz Inacio Lula da Silva of Brazil and Hu Jintao of China are meeting this week in Beijing. According to several news accounts, unnamed sources stated that the talks are not about currency swaps (as we've seen between China and other central banks). Supposedly, China and Brazil are in the early stages of considering an arrangement whereby China would be able to buy Brazilian goods with renminbi (yuan) and Brazil would be able to buy Chinese goods with the real.

If that comes about, it would be the first move towards a floating renminbi -- and thus, a very big "small" step indeed. Because if China is ready to float the renminbi in any way, shape or form, that will further confirm that the Chinese are in the process of turning their back on the dollar, despite their official protestations to the contrary. But in fact, China needs to have it both ways -- i.e., jawbone us to not do anything foolish (which everyone knows we're doing and will continue to do), while attempting to figure a way out for themselves. So, this is a development worth keeping our eye on.

RCM Editorial: It Takes A Lot of Manure To Get These "Green Shoots"

The equity markets continue to work their way higher as the government-sponsored and controlled bank stress test pageantry is in full swing. In my business we commonly refer to this type of charade as "putting lipstick on a pig". However, the herd is content at the moment to try and make that silk purse, so we must respect the trend and trade from the long side. My advice: remain alert, we are witnessing the greater fool theory in full force. Keep one foot out the door or the market will cut off your legs when it turns.

I have heard a lot of talk about Ben Bernanke's "green shoots" comment in regards to the economy. He points to different economic numbers that have been released over the last 6 weeks as reasons to be optimistic. I was asked about this "green shoots" theory during the interview I gave on The Financial Lifeline Radio show Monday. My question in return:

What does it take to get these "green shoots"?

Answer: A lot of manure.

Enough said about "green shoots" let's make a reality check:

Creditors object to Chrysler deal, setting up fight
NEW YORK (AFP) - - A group of Chrysler creditors objected Monday to the struggling automaker’s bid for a quick restructuring, calling it an illegal bid by the government that violates constitutional property rights. More…

RCM Comment: The government conjures up green shoots by stepping all over the Constitution. Maybe Bernanke was right, yes something is growing, but it's green mushrooms and they are poisonous.

Mike Morgan:

The moratorium on foreclosures lasted five months. That’s over now. And real estate brokers have been warned to expect a tsunami of properties to be listed and sold.

Foreclosures are increasing in the luxury space. Prime borrowers are now losing their houses and these repossessed homes are recorded as sales in the national figures. So, now you have a "green shoot" reported by the press as "increasing home sales". Then (to add a little more manure onto the "green shoot") the press reports the increase in median home sales prices as a positive. Of course, the increase comes from the repossessed luxury homes that are valued at higher prices, but no one in the press bothers to mention that little annoying detail.

RCM Editorial: Believing in The Gold Bull Market. Does it Take Faith or Simply Common Sense?

I feel compelled today to discuss what I am hearing is the eminent demise of the Gold bull market. I have been forced to field emails, phone calls and, yes, even a text message on this topic over the last couple of weeks. To say the least, I am disappointed with some in our flock. Over the last 3 years we have painstakingly laid out the road map to perhaps one of the best bull markets in history. Gold prices have out performed all major asset classes in the last 5 years and in 2008 increased 5% while the rest of the financial world was imploding. In the midst of this financial desert, our commitment to Gold last year led to profits for the limited partners of Fortune's Favor I and Fortune's Favor Precious Metals. Gold had a wonderful start to 2009 and in the last 6 weeks has pulled back roughly 10% from the highs. A well deserved rest and a necessary coiling for the 3rd assault on the $1,000 mark that will take prices to new bull market highs.

I am loath to get biblical, but I imagine my discouragement may be akin to that of Moses and his experience with the Ten Commandments. Indulge me for a moment before you roll your eyes at what you perceive to be a bombastic statement. I have basically come down from the mountain with the tablets to investing success and in a few short weeks some of our followers are dancing around a fire built by the heathens of the oft manipulated news media. In an ironic twist, instead of worshipping gold these nonbelievers have been led astray by price weakness (10% off the top would be considered small in any circle), supposed IMF gold sales and a general misguided belief that if the markets go up Gold goes down as the fear trade subsides.

Of course, this is where the juxtaposition with Moses ends. You see, believing in G-d takes faith, but believing in the Gold bull market simply takes common sense.

Has anything really changed the picture in the last 6 weeks? Let's review:

-The tsunami of fiat currency creation around the world is perhaps the single biggest supporting factor for the Gold bull market. Have we witnessed a miraculous about face of governments around the world in the last 6 weeks indicating a tightening of credit and fiscal responsibility? I don't think so. In the U.S., the Fed's balance sheet has more than doubled in size since August. If you think that expansion is coming to an end you are sadly mistaken. During the last 6 weeks, instead of planning fiscal responsibility, the Fed completed an internal study condoning - in fact, encouraging - further balance sheet ballooning. And I'm not talking about the balloons on the back of a birthday chair. I'm talking about the kind that fills with hot air and carries a basket. Want details? Read this story, you will not believe it:

Fed study puts ideal US interest rate at -5% - FT reports the ideal interest rate for the US economy in current conditions would be minus 5%, according to internal analysis prepared for the Federal Reserve's last policy meeting. The analysis was based on a so-called Taylor-rule approach that estimates an appropriate interest rate based on unemployment and inflation. A central bank cannot cut interest rates below zero. However, the staff research suggests the Fed should maintain unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5%. Fed staff separately estimated what size and type of unconventional operations, including asset purchases, might provide this level of stimulus. They suggested that the Fed should expand its asset purchases by even more than the $1,150 bln increase policymakers authorized at the last meeting, which included $300 bln of Treasury purchases. The assessment that the US central bank needs to provide stimulus equivalent to a substantially negative interest rate is unlikely to have changed ahead of this week's policy meeting. (In order to achieve a rate of -5% interest this implies the Fed is targeting an inflation rate of at least 5% with the Fed funds rate at 0%. We are frankly surprised the study was actually made public. This policy suggests the Fed is deliberately targeting a decline in the US$, which is contrary to the government's public rhetoric.)

-Some misguided souls have argued the fear trade is leaving the market. Apparently, the world is a safer place and that's why gold is trading down 10%. This is such a ridiculous supposition that I find it difficult to address. During the last 6 weeks North Korea has sent a missile over Japan, the Taliban are enforcing Islamic rule in parts of Pakistan as war brews and meanwhile, our President is bowing to kings in the Middle East and forming a rather dubious book club with dictators in South America. I think the real reason for the 10% swing in Gold is really rather boring. No market goes up in a straight line. Corrections are necessary to shake out the weak holders and build a base to launch new assaults on the old highs. Since this is a mundane answer it would never work on CNBC. The news media needs to sensationalize in order to captivate. Beware, sometimes market volatility creates news, which can be misleading.

-I will conclude with a comment about the IMF Gold sales and a friendly wager. First, let me be clear, the proposed sale by the IMF is not new information and therefore was not a shock to Gold market participants. The G20 communique read, “…Additional resources from agreed sales of IMF gold…” will go to support developing countries. This is not a declaration of new sales agreements. Second, the communique read, "…To provide $6 billion…over the next 2 to 3 years…” Let's breakdown the numbers shall we?


IMF holds 103.4 million ounces
Current value of holdings at $900/ounce = $93.6 billion
Proposed sale as per communique = $6 billion roughly 6.6 million ounces
Avg. daily ounces traded on the London Bullion Market as of Feb. 2009 = 23.8 million ounces
6.6 million ounces sold will have virtually no impact on the Gold market today let alone over the next 2 -3 years.

And here comes the wager: Western central banks scoff at the importance of Gold and attempt to manipulate the metal lower with well-timed comments and outright sales in order to continue the farce of fiat currency creation. Meanwhile, the East is buying with ever increasing vigor. If the IMF wanted to sell this 6.6 million ounces all at once China could very well be the buyer. We will wager that the day this deal is announced Gold prices will end higher not lower. In fact, we would not be surprised to see the Chinese bid a premium for the entire IMF Gold position. Curious about the Mandarin metal mandate? Look no further:

China reveals it has 1,054 tons of gold - Reuters Reuters reports China revealed on Friday that it had quietly raised its gold reserves by three-quarters since 2003, increasing its holdings to 1,054 tons and confirming years of speculation it had been buying. Hu Xiaolian, head of the State Administration of Foreign Exchange, told Xinhua news agency in an interview that the country's reserves had risen by 454 tons from 600 tons since 2003, when China last adjusted its state gold reserves figure. The world gold market has been buzzing with talk about China buying gold for years as the country's foreign exchange reserves have rocketed, and speculation has picked up since the global economic crisis threatened to weaken the value of those reserves. Gold prices jumped on the news and were up 1% on the day at $910.80 an ounce at 0540 GMT. By a Reuters calculation, China's holding of gold would be worth $30.9 bln at current prices.

RCM Editorial: Banks' Earnings Scorecard

Big banks with government support VS. Smaller banks operating in the real world

"Better than expected" EPS (the big banks)

Wells Fargo (WFC)

Goldman Sachs (GS)

J P Morgan (JPM)

Bank of America (BAC)

Worse than expect EPS (the smaller banks)

Keycorp (KEY)

Pacwest Bancorp (PACW)

SVB Financial (SIVB)

US Bancorp (USB)

Zion Bancorp (ZION)

State Street (STT)

Bank of New York Mellon (BK)

Comerica (CMA)

Huntington Bancshares (HBAN)

Northern Trust (NTRS)

ETC. (Too many to list, but you get the idea)

So the jury is back and the results were as expected for those of you who follow this blog. Over the previous few blogs the banking analyst at Rosenthal Capital Management (that would be yours truly) presented a case for a rather egregious dichotomy developing in the banking space at the behest of our government. In a desperate attempt to reverse investor sentiment and create an environment for banks to raise capital, the government changed rules and gave support to the biggest banks. The last 5 weeks have been rife with "positive" announcements from the big banks that led to a spirited stock market rally. Companies like GS have jumped at the opportunity to raise capital. GS issued new stock at $123 / share, raised $5 billion and the stock has not traded above $123 since even though we were told the deal was dramatically oversubscribed (the stock trades between $113-$115 as I write this).

Week 6 of the stock market rally is underway and reality can no longer be avoided or covered up. The smaller regional banks are announcing earnings and without the help of government the numbers can only be described as macabre.

Important Rule: The reaction to the news is more important than the news.

The direction of the market in the coming weeks can certainly be debated. Yes, we were right on the news, but often it takes time for the herd to respond to reality. Cracks in the foundation of this market rally have formed. Momentum is waning as the market moves higher and volume signals are flashing yellow. However, a market responding to government manipulation can be hard to predict short term so caution is the word of the day.

RCM Editorial: Is This Rally Sustainable? Goldman Sachs Gives Hints & Meredith Whitney Weighs In

The cause and durability of this equity market rally continues to be a hotly contested debate. I would like to throw my hat in the proverbial ring and offer some thoughts on durability.

Every market rally - whether it be a bull market or bear market bounce - has a group that leads the move. By studying this group we can get some insight into the strength of the overall move. In this case, the financial sector clearly led the markets off the bottom and an examination of the ability for this group to continue its rise may be helpful. The rise off the bottom for the financials can be attributed to a few main reasons:

1)Dramatically oversold conditions led to a much needed reprieve
2)Launch of TALF
3)Launch of PPIP
4)Fed monetizing of debt (announces $300 billion program to buy U.S. Treasuries)
5)Real estate numbers released by the government are "sold" as positive. (Only a sucker would buy this idea. Please see the 3/25/09 blog for more details.)

The question remains: can the financials continue their rocketesque launch off the lows and make it to orbit, or will they fall back into the ocean like a failed North Korean missile launch? I will offer up the following thoughts and let you be the judge:

1)Government initiatives can create near term excitement but historically cannot change the long term direction
2)Real estate reality will return and continue to be an issue that is hard to ignore. Read the story on U.S office vacancies before you debate this idea with me.
3)Earning season is starting and the numbers will highlight a glaring bifurcation in the financial sector. Those banks working with the government to unwind AIG will show "better than expected" numbers. Those banks on the periphery will not. I suspect this schism will lead to a selloff on the news and create a mistrust of the numbers.
4)Banks need capital and will use this recent rally to raise it at the expense of current holders

I offer the following two stories as support for the thoughts above:

Goldman Sachs considers share sale to payback govt loan - Daily Telegraph
Daily Telegraph reports the co, which will report its first-quarter results on April 14, is expected to announce on the same day that it is to submit a formal application to repay the sum given to it as soon as it passes the formal "stress test" being conducted by govt officials on all major US financial institutions. People close to the bank say that its management, led by chairman and chief executive Lloyd Blankfein, is assessing a range of options for repaying the money loaned to it as part of the US Treasury's Troubled Asset Relief Programme. These include orchestrating a new share sale or funding the repayment from existing capital resources, and it may still decide to pursue the latter route. Goldman, along with a number of its rivals, is understood to have enjoyed a spectacular first three months of the year in terms of its trading performance, according to insiders. The bank would not require additional capital to repay the Tarp money, having raised $11 bln from investors including Warren Buffett, the so-called "Sage of Omaha", last autumn. Some senior Goldman officials believe, however, that the ongoing banking turmoil means that it should continue to take a conservative view of its balance sheet and exploit further opportunities to raise additional capital if it is accessible on reasonable terms.

Meredith Whitney - Meredith says shes not bullish by any case, but would be very careful pressing shorts here. She says all rules are subject to change once you bring in the government into the picture. She says the reality is tangible book values will go higher in the near term. When asked if she would commit capital to the financials she says this qtr is going to look stronger, perhaps private capital comes in to support some of these financials. Co says the new housing data is the "head fakes of all headfakes". When asked about earnings in the financial sector she says several technical and one time factors will lead to Q1 profits and capital creation. Meredith says some investors may buy into earnings and react the way they reacted to Friday's NFP number and think the worst is over. She believes these investors are incorrect and after the stress test findings come out, she says some decent size banks will not pass the stress test. She says be careful at the end of the month when the stress test findings come out, it will be another grim period for financials

RCM Editorial: An Explosion of Debt Relative to GDP

RCM Comment - Gary Rosenthal:

Examine the Total Credit Market Debt vs. GDP chart below and you will quickly realize why all of the government's bailout programs are paper tigers and are destined to miss their intended mark by a wide margin. The credit collapse of 1929-30 did not hit bottom until the early 1950s. The strong U.S. economic expansion from the early 1980s until recently was driven by an extraordinary rapid climb in the amount of debt per dollar of GDP. At its peak in 2008 total debt per dollar of GDP was dramatically higher than the peak of 1929-30. In a single snapshot you can see that the U.S. consumer has completely lost his credit worthiness at a time when the banking system has regained its sanity and adopted lending standards not seen since the 1950s and '60s. In short, until U.S. consumers substantially repair their balance sheets (through savings or bankruptcy) consumer expenditures (and in turn the U.S economy) are likely to be on a downward spiral for an extended period of time no matter what the government tries to do. No amount of government spending will offset the vicious cycle of a collapse in consumer spending and rising unemployment.

The government's misguided Keynesian answer to declining tax revenues is sharply accelerated spending, unprecedented budget deficits and borrowing and higher taxes. Common sense would tell you that something is completely out of whack with this formula. Who would lend money indefinitely to a government who has completely lost control of fiscal responsibility? The answer is that eventually no one. Thus this program of uncommon sense will eventually be largely funded by the printing press until the U.S Dollar loses its role as a reserve currency with our trading partners. How long will it take the Dollar to lose its place in international finance is anybody's guess, but the next time gold goes through $1000/ounce it is very unlikely to come back.

MISH'S Global EconomicTrend Analysis:

The chart below from Ned Davis illustrates the real problem: An explosion of debt relative to GDP. In Geithner's plan, this debt won't disappear. It will just be passed from banks to taxpayers, where it will sit until the government finally admits that a major portion of it will never be paid back.

Total Credit Market Debt vs. GDP


















The above chart is similar to those detailed in Fiat World Mathematical Model. Here is the ending snip on psychology that is at the heart of the matter.

Political Will vs. Consumer Psychology

What happens next depends somewhat on the political will of the central banks and politicians. However, it depends more on the psychology of the borrowers. If consumers and businesses refuse to spend and instead pay back debts (or default on them along with rising unemployment), the picture simply is not inflationary, at least to any significant decree.

The credit bubble that just popped exceeded that preceding the great depression, not just in the US but worldwide. Thus, it is unrealistic to expect the deflationary bust to be anything other than the biggest bust in history. Those looking for hyperinflation or even strong inflation in light of the above, are simply looking at the wrong model.

At some point the market value of credit will start expanding again, but that is likely further down the road, and weaker in scope than most think.
Henry Blodget's Five Misconceptions are another way of looking at the psychology of the situation. The sad reality is that both Geithner and Bernanke are trapped in academic wonderland with failed models about what happened in the Great Depression and why.

Geithner said "Simply hoping for banks to work these assets off over time risks prolonging the crisis in a repeat of the Japanese experience." I agree. Unfortunately, Geithner's solution is to Zombify the taxpayer instead. What needs to happen is for banks to write off the bad debts. The Fed pleaded with Japan to do just that. Now Bernanke and Geithner refuse to follow that advice.

Bear in mind this insanity is just round 1. When it does not spur lending for reasons stated above, Geithner will be back at it begging for more taxpayer funds to bailout the banks. By the way, is this even legal? Offering no collateral loans is a handout. Many on the Fed, including Bernanke have stated the Fed can provide liquidity not capital. What is a no-recourse loan but capital? Of course the Fed is offering these guarantees via the FDIC.