Tag Archives: investing

On Gold, Guns, Bread and Cadillacs…

Well, maybe not guns.  This isn’t that kind of post.  But I am going to talk about gold briefly.  One of the more interesting ways to think about the value of gold is its value in purchasing household items.  Because back in earlier times that was exactly how you paid for things.  Gold is money, after all.  Indeed, in the book “Hedgehogging” Barton Biggs refers to gold in such a manner:

The Old Testament recounts how, in 600 B.C., one ounce of gold bought 350 loaves of bread.  As of today, one ounce will still buy 350 loaves of bread in the United States.

Barton Biggs: Hedgehogging

In my area of the country in North Carolina, one ounce of gold will get you 446 loaves of bread.  So when measured in those terms, we’re overvalued even after the action we’ve seen over the past few months:

Today I heard it referred to in another way: gold vis-a-vis Cadillacs.  So first, I have to present to you the definitive video clip on Cadillacs…

And now back to the gold/Caddy ratio.  I stumbled across this post (hat tip: @hedgefundinvest and @FinanceTrends) that looked at the fact that in 1971 with gold pegged at $35 an ounce you needed about 11 pounds of gold to buy a ’71 Eldorado.  Take away the peg and it would’ve been much less gold (at $103 an ounce you need about 5 pounds).

Now?  You can get 2 Cadillac XLR-Vs for the same 11 pounds if you’re taking the $35 per ounce as your starting point.  If you used 5 pounds, well you’re out of luck because you won’t have enough based on Friday’s close at $1193.50.  So the starting point you choose is important.

But as for the overvaluation or lack thereof currently?  At these levels it may still be overbought even though we’ve seen a pretty sharp pullback from $1,250.  But I’d be wary about how much more of a decline we see here because volume has been higher even on up days and the revolt against central banks isn’t over by any stretch.

So in my mind, we’re in for more volatility not less.

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I Guess I’ll Say it Here…: America’s Lost Decade

Left this comment for Sean McLaughlin, but I thought I’d share it here as well (emphasis, mine):

Sean, this is great.  Thanks for sharing.  As someone who focuses on long term/bigger picture timeframes as opposed to intraday, what your post talks about is the importance of keeping your risk/return objectives and timeframe in sync.

I’ll tell you for me, the noise I strive to filter out is the daily/intraday moves a lot of traders are looking to in order to make money.  But the big picture moves I use to strategically build/unwind positions are the things intraday guys filter out.  So we’re running around each other trying to block out what the other group is doing.

It can drive you mad, but it’s worth it if you do it right.

via I Guess I’ll Say it Here…: America’s Lost Decade.

And sometimes I should listen more to my own advice…

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What to Do With All That Cash…

This is an extension of some discussions I’ve been having and some blogs I had recently written on inflation and bonds.  Because as you think about inflation and investment returns, you inevitably come to a point where the discussion turns to the cash on corporate balance sheets.  I was going to put up some charts based on the Federal Reserve’s Flow of Funds data but thanks to Google, the Trader’s Narrative and the good folks at the Financial Times, I don’t have to (click here for the video).  But let’s take a look at some of these charts to tee this up:

Indeed, this view shows there’s a record amount of cash available. But when you look at it on a debt-adjusted basis…

Not so massive a pile now, is it?

Share buybacks seem to be the most obvious use of the excess cash at the moment.  And with good reason.  The prospects for future growth don’t look particularly good at the moment.  So if you were going to do fundamental analysis of equities right now via a dividend discounting model (let’s use the Gordon Growth Model as an example):

Your denominator gets larger as the spread between required rates of return and growth rates expand.  And as a result, the valuation for the stock is lower. If this sounds like a bearish case based on fundamental analysis, it is.  How do you boost the price in this event?  Simple: demand a lower rate of return.  Good luck in getting your investors to go along with that.

But let’s try to take this train of thought and think strategically.  If you’re a corporate Treasurer or CFO and view the economy and your business the same way, that means you would be expecting P/E multiple compression: prices fall while earnings level off and growth rates turn anemic.  All of which leads to an interesting question: why do a buyback now if you can get more bang for the buck later?  The case could be made for saving some dry powder.

As always, feel free to leave a well-reasoned, on point comment.

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I’ve Got Some Theories About The Real Estate Tax Credit

I read this post from Jacob Roche about what has happened in housing since the tax credit expiry.  There are a couple of surprising aspects to what we’re seeing so far.  First, a look at prices (emphasis, mine)

What I found was that on both a raw and population-weighted basis, prices increased after the tax credit expired, by about 5% in both measures. Most interestingly, on a dollar basis, prices increased by a raw $9,766.77 and a population-weighted $5,280.89 — very close to the $8,000 credit. This is extremely counter intuitive. If the tax credit expiration effectively raises all home prices by $8,000, why would sellers raise their prices roughly another $8,000, and why would buyers agree to it? In some areas, like New York, DC, and San Francisco, prices increased by the tens of thousands. Also interesting is that some of the biggest price declines occurred in Texas, although removing Texas from the population-weighted data changes the average by only a small amount — the biggest percentage decliner in the list is in Texas, but it’s also the smallest city in the list.

via Real estate prices, post tax credit.

The post goes on to look at the sale data (again, emphasis is mine):

Number of sales gives the data another dimension however. Roughly three-fifths of the cities in the list saw fewer sales post tax credit, and the declines in sales were generally much steeper than any of the increases. It’s regrettable Trulia doesn’t give the exact numbers, making it difficult to estimate how much money is flowing in or out of the market, but one could at least make a rough guess that the price increases are being offset by fewer sales. Interestingly, a couple of the cities with declining prices saw increased sales.

Now I have some theories about this behavior, purely using intuition and my own read of buyer and seller psychology.  On prices, I think the sales price increase is a sign sellers know the market is not as liquid now as it was with the tax credit.  So as a result they’re looking to maximize the price paid.  I would’ve thought prices would’ve been higher under the tax credit because both buyers and sellers would treat the credit as “found money.”  What I mean by that is if you find money that you had no expectation of getting, you’re more likely to splurge – to spend on things you may not have thought of getting before, but since you have the cash you decide to get it anyway.  Apparently it didn’t quite work out that way.

As for sales volumes, that’s not a surprise.  We figured sales would be lower as the market becomes less liquid.  And Jacob’s point about money flow is a good one.  Because ultimately that’s what it’s all about.  So when pundits talk about Case-Shiller price increases, my first question is how many sales-pairs made up the estimation?  Fewer transactions at higher prices can still result in negative money flow.

Overall, I think the tax credit did more harm than good.  Prices offered and prices bid are moving further away from each other, thereby resulting in fewer housing transactions which are actually done.  The market is becoming more illiquid and the process will take that much longer to heal itself and for transactions to clear in a meaningful way.  Plus, how much money was spent on this and did it get us the outcome we wanted?

Don’t think so…

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On Inflation and Bonds… in < 140 Characters

Today I saw an interesting tweet from Jennifer Ablan:

And based on a daily move like this…

you get the impression there’s a divergence.  Stocks have a gangbuster move to the upside while bond yields have been moving lower.  Is Goldilocks appearing again?  Hardly.

But I had a response for her:

Yes, I cited Japan as the example.  But I don’t think they’re going to be alone.  Indeed, there are a couple of ways to look at inflation.  One is just prices paid and you can use the Consumer Price Index or the Personal Consumption Expenditure index.  Well, by either measure, they’re headed lower:

PCE hasn’t fallen the way CPI has but they are both still going lower.  Why?  Because as Steve Keen demonstrated with his Minsky-based approach, aggregate demand is falling because private debt is collapsing and unemployment is rising:

And the 2/10 spread has responded in kind:

One point I’d make is that when you step back and see what’s going on in bonds, unemployment, inflation and debt is there could be a new feedback loop between these things that has taken root.  I don’t know the mechanics of it, but I’d say there’s a link between these phenomena going on.

And it isn’t pretty.  Just ask the Japanese how well things turned out for them the last 20 years…

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Where the Streets Have No Names, Lights or Signs: A LIBOR Update To Remember

For reasons I’ll explain in a bit, this is going to be a critical week for Libor funding.  But before I get to that, I want to recap what has happened in the Libor markets this past week.  So let’s take a look at the usual suspects charts:

The kink between the 6mth and 1yr Dollar Libor maturities is flattening a touch.

Meanwhile, Euro Libor is shifting out.  Noticeably.

As for Yen Libor, well, just leave it alone.  It’s sleeping so soundly I don’t want to wake it.

But let’s take a look at some weekly snapshots of the Dollar and Euro Libor curves:

Dollar Libor is relaxing some.  Not that it’s relaxing that much, but the acute funding pressure we had seen building has softened a bit.  This shouldn’t surprise us as this move coincides with the Euro move to the upside.  Here I show the hourly chart going back two weeks.  This should tell the story well enough:

Which also shows up in Euro Libor:

What we’re starting to see is a kink formed at the one month point on the curve.  Mid-dated Euro funding is getting bid up while overnight funding remains dormant.  This next chart shows that:

Outside of the two hiccups 35 days apart, that is.

But now, things get interesting.  While I was on the road, zero hedge ran this post about funding conditions in Europe.  I took this screen capture of the ECB’s OMO page:

I circled those two transactions because they settle within a day of each other.  This week.  So within 2 days, we’ll see almost €600bn in ECB reverse transactions settle. What is a reverse transaction?  From the ECB’s General Documentation on Eurosystem Monetary Policy Instruments and Procedures:

Reverse transactions refer to operations where the Eurosystem buys or sells eligible assets under repurchase agreements or conducts credit operations against eligible assets as collateral.

So you can either structure these to take liquidity out of the system, or put it in.  Trust me, these were injecting liquidity in to the system.  But now they’re coming due, and I want to use this to show how inflation is not the issue to worry about and hasn’t been for a while.

How?  Well, take a look at how much is now owed to the ECB:

For the small facility on 6/30:

(€151.5114bn)[1+((7/360)(1%))]  = €151.5409bn

For the large facility due on 7/1:

(€442.2405bn)[1+((371/360)(1%))] = €446.7980bn

In a world where credit costs are minimal (extremely low default rates, good recoveries on collateral, charge-offs almost nil, etc.), this wouldn’t be an issue.  Heck, the facilities wouldn’t have been this well-bid in a good credit environment.  But we’re not in that kind of environment now and the credit cycle still has a ways to go before we can see a true recovery there.  Plus, other assets like sovereign debt securities are having their own issues.  Banks might hold some of these notes, so now you’re talking about a hit on the balance sheet again with the recent credit market action, in addition to the rising credit costs. Oh, and I forgot to mention falling loan demand.  So amidst this backdrop, banks are going to have to come up with this cash.

And to make matters worse?  Consider Spain:

Spain faces a confluence of events in July, whereby it will need to finance 21.7 billion euros within a single month. This combines shortfalls in its budget and a wave of scheduled government debt redemptions.

via Spain’s Debt Maturity Wave Hits Next Month And It’s Already Obvious They Don’t Have Enough Cash.

The problem here is two-fold: first, there are the questions about what the cost will be – i.e. how much will the spread to German bunds be.  Second, consider this (emphasis mine):

It goes without saying that the government’s priority will be smooth and well-bid auctions (see calendar below), with local banks playing a crucial role.

So Goldman obviously expects banks to be bidding on these notes.  Below is the Spanish debt auction calendar in question:

The 5yr bond auction takes place the same day the monster ECB facility expires. Can this get any crazier, or what?

Looks like the Euro Libor market is becoming less and less certain, of well, a lot.  Take a look at the spread term structure:

Dollar/Euro Libor spreads are widening a bit, but not for the right reasons.  It seems now that the increases in the term structure of Dollar/Euro Libor spreads are being driven by uncertainty over the June 30/July 1 settlements.  Given the nature of the activtiy in the funding markets, I’ll probably write something before next week on this (i.e. look for a post later in the week as we approach month end).

Because as of right now, this like driving in a foreign country where no streets are named, numbered and there are no traffic lights or signs.

But the sad thing is, we’re not driving.  We’re standing in the middle of the intersection while everyone converges from all 4 directions at death-defying speed.

There’s only one way I can see this ending “well.”  The ECB will have to announce a new facility to roll all of the collateral that has been pledged and the banks can keep the Euros the ECB lent them.  For now, anyway.  But there has been no indicator they’re working on this.

Better find something to hold on to and brace for impact…

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How Quickly Are We Turning Japanese?

I came across this piece from the Business Insider.  Their post talked about one of the more surprising aspects of this recession: the low default rate in high yield credit.  I’ll openly admit, in the words of Frank Vitchard, “I did not see that coming!”

They referenced a Fitch report, “The Extreme Credit Cycle – Making Sense of a 1% U.S. High Yield Default Rate”, which talks about this development.  According to Fitch, the high yield default rate went from 13.7% with 151 defaulters last year, to a forecasted 1% default rate for this year.  A stunning drop, to say the least.  But let’s a take a look at the following chart, which comes out of the report:

The thing I note is the divergence in growth rates between TTM revenues and TTM EBITDA we’ve seen since ’07.  In ’05 and ’06 you can see  the growth rates tracked pretty closely together, but in ’07 as the economy started wobbling, TTM EBITDA started turning negative.  Plus, EBITDA went lower, farther and sooner than revenues.  But EBITDA growth is slowing down, possibly peaking.  Not much of a surprise since we knew companies were cutting costs via layoffs and forgoing cap ex.  But what are we talking about when we refer to EBITDA?  From WikiInvest:

EBITDA = Income before taxes + Interest Expense + Depreciation + Amortization

via Metric:EBITDA.

Ah, yes…. Earnings Before I Trick the Damn Auditor… actually it’s Earnings Before Interest, Taxes, Depreciation and Amortization.  I don’t particularly like the metric because the things it leaves out are, well, kind of important.  But the metric is supposed to reflect a relatively clean cash flow measure.  I guess to me, aside from the drop in income (which is obvious), the thing I’m most curious about in the high yield space is which component had the biggest impact in the second half of ’08 as well as the second half of ’09: was it interest expense? Or depreciation and amortization?  The answers we get there can help explain why we’ve seen such a dramatic drop-off in default rates.

My theory is interest expenses have taken such a dramatic cliff-dive it has only served to help high yield companies in managing interest costs and as a result their weighted average cost of capital.  This differs from Fitch’s conclusion that it’s the cap ex piece.  How did I arrive at that?  Let’s take a look at the chart:

The coverage metric EBITDA less CapExInterest feel further going from a peak of just over 3 times coverage to roughly 1.5 times coverage – about a 50 percent drop in a coverage metric.  Yet the EBITDA/Interest only fell from a peak of near 5 times coverage to a low just under 4 times coverage.  So I don’t buy the reduced CapEx story all that much.  I think the story is really in the reduced interest expense.

And on the heels of that, we read this from Bloomberg:

Investors are returning to junk bonds after the worst month since 2008 on speculation the economy is growing fast enough to avert corporate defaults without sparking inflation.

“High yield is the place to be,” said Manny Labrinos, a money manager at Nuveen Investment Management who oversees $1.8 billion of fixed-income assets. “Sub-par growth is somewhat of a Goldilocks scenario because it means rates stay low and people are still going to reach for yield.”

High-risk debt has returned 1.76 percent in June, almost double the gain of investment-grade corporate bonds, Bank of America Merrill Lynch index data show. Underscoring demand, CNH Global NV, the Fiat SpA unit that makes tractors and harvesters, boosted the size of its speculative-grade offering by 50 percent to $1.5 billion in the largest junk-bond sale since April 20.

via Junk Bonds Revive on Bernanke `Sub-par’ Economy: Credit Markets – Bloomberg.

So the paper is exceptionally well-bid, but what would you expect in a rate environment like ours?  Indeed, as one of the more astute people I follow on twitter said:

And this:

The reason I worry about it is the same reason I worry about sovereign deficits.  The amount of debt worries me not because I think there’s some magic debt/GDP number from which there’s no point of return, but because low rate environments are highly convex and rate shocks can kill.  Especially when growth rates for GDP, earnings, etc. grind lower.  At some point, you’re bound to have a problem.  I’m going to cover more on the sovereign-related stuff later.

In the meantime, chew over the idea that with rates so low and liquidity being so excessive, defaults in high yield will continue to surprise to the downside, grinding returns lower still.

Seems we have started another feedback loop, just like the Japanese did, 20+ years ago…

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