The Three Big C’s: Commodities, Canary, China

Economists and analysts and politicians are telling us how good it is that commodity prices have fallen. Get your oil while it’s cheap says our president. Yes it’s great that things are cheap I agree but why dear God why are they so cheap? What has changed? Let me put it this way…

If the world was a coal mine, these guys would all die with the canary. They see an effect but no cause. When the canary stops chirping these guys say “Oh how wonderful. It’s so nice and quiet.” They don’t ask the question why is the canary dead? They don’t ask why are commodity prices are falling?

Yes, why are commodity prices falling? There a few obvious factors such as a stronger dollar and falling demand. The world economy is slowing down due to generational patterns in the developing world as a result of WWII. Yes we still feel the effects of WWII today. When you wipe out tens of millions of people in just a few years time which is quickly followed by the largest burst in population in the history of the world, you tend to get some lingering generational effects. But it’s not just developed countries that are slowing down.

China, the world engine, has been preparing for a hard landing for the past decade. Some how they’ve managed to scoop enough water out of the boat to keep it from sinking. But there is a cost. As I predicted in my first post back in December of 2013, that China would slow down and although we wouldn’t get accurate data from the Chinese themselves we only have to look at what’s going on with their trade partners and the commodities they consume.

First thing’s first, commodities are falling like it’s the second great recession. Oil wasn’t the only commodity to lose half it’s value in a year. Iron ore suffered the same fate as well. Copper is in the tubes and still falling.  So what about China’s trading partners? Well Australia and Canada aren’t doing too well. Weak demand for the commodities they export is starting to hurt their economies. So what do they do? Well they devalue their currency to make their exports more competitive. But China isn’t doing that. China has it’s yuan pegged to the dollar. So when the dollar strengthens so too does the Yuan. A strong Yuan hurts chinese exports which causes a slowdown in their economy which in turn hurts their trade partners who devalue their currencies which once again reinforces a strong Yuan. How long does this go on for? Does China devalue the Yuan? These are questions for another time, but I doubt the SNB will be the only group of unelected bureaucrats to go back on their promise.

Stating The Obvious: ECB’S QE Will Fail

I feel like a nerdy sci-fi reference is long overdue and what better way to jump into the European Union’s problems than with a reference to the best show to ever be canceled, Firefly. On the show, humanity has left earth and colonized/terraformed an entirely new solar system. The CORE planets or those closest to the star formed The Alliance, an interplanetary union. With their combined strength and technology they were able to conquer and extend their sphere of influence over the outer planets which were seen as backwaters and underdeveloped. The show takes place following the failed uprising of the periphery planets over the core planets. Our main characters are a group of outlaws who navigate the murky backwater planets while avoiding the overreaching control of the Alliance. Of course, the show takes place in this unique and strange world that has absolutely no similarities to the one in which we live today. So I actually have no idea why I even brought it up.

Seven years into the Eurozone’s depression the ECB decides to print money in a desperate attempt to buy even more time for the European Bureaucracies to sit on their hands. It’s insane to think that the politicians in charge of Europe will do anything different with the added 6 months, maybe a year of time the ECB just bought them. They didn’t do anything for the first seven years why should another year change that?

Draghi is in essence doing the classic spray and pray tactic employed my most video gamers when a random bad guy jumps out from behind a corner. Unfortunately the money he’s spraying is a drop in the bucket compared to what would really be necessary for him to blast his target of 2% inflation to smithereens. I don’t want to put a number on it, because that would be falling folly to the very same “logic” these arrogant psychopaths employ so well. Needless to say 1.1 trillion Euros isn’t enough to save the EU from itself.

If Draghi or anyone at the ECB was a student of history they’d know this. Hell, they don’t even have to be students of history. All they’d have to do is look at what is going on in Japan. Japan’s economy is 1/3rd the size of the EU. Yet the ECB is planning on printing the same amount of money per year.  Last time I checked, Japan wasn’t suffering from too much inflation even with the absurd amount of money they have been printing. From a basic numbers perspective, the failure of the ECB’s action is all but guaranteed.

Perhaps the amount printed doesn’t even matter. For no amount of money can save the EU when it is this divided! Only 20% of the purchases will be shared. 20 freaking percent! This low amount of risk sharing speaks volumes about the division in the EU, which is behaving more like a confederacy of nation states than the union it claims to be. The lines are already being drawn. The periphery resents the core for harsh austerity and the core has grown impatient with the periphery’s inability to grow out of its debts. We can already see this resentment growing in the periphery countries like Spain and Greece who is on the verge of electing the uber left wing Syriza party. Everyone knows the Greek debt will never be repaid. How long till they finally act on it?

More Evidence The Fed Will Hike Soon and Slowly

2015 is going to be quite the year for central bankers (Isn’t every year?). The SNB reneged on its promise to keep the CHF pegged to the Euro and has caused what seems to be irreparable damage to the public’s trust in said institution.  I’ve been long European Equities since the Swiss abandoned the peg virtually waving the white flag for the ECB to step in and restore public faith in central banking omnipotence with a QE programs two and a half years in the making.

Back in 2012, Draghi said he would do whatever it takes and that it would be enough. I believe the first part but not the second. You can’t expect to slay the deflation dragon by pushing on a string, especially with both hands bound behind your back with the Gordian knot that is European Governance. You’d think after a few centuries of notably pathetic attempts at central planning, kings presidents or whatever you call the man sitting on the throne would step back and realize that they are no different then their predecessors. Which is probably a good thing because who would want to live in a world where their ego-maniacal theories actually hold water?

I’m getting off topic. Back to Draghi, who I should be thanking for the extra cash I’ve made this week due to my leveraged long European equities position. He’s finally making good on his promise and he’s not the only Central Banking Overlord that will do so.

The Federal Reserve has promised to raise interest rates in the first half of this year. Although most people seem to think they’re full of goose poop, I am of the mind that they will do it sooner than expected. To help support my theory I present, the president of the St. Louis Fed, James Bullard.  He was talking to the WSJ, but who needs them when all you had to do is listen to me two weeks ago iterating the same thing.

Mr. Bullard said U.S. long-term rates are being pulled down by global factors, and not new threats to the domestic economy. He wants to “get going” with rate increases.

I advise you to read the whole article for yourself. There are some other juicy quotes that I left out for brevity, but the synopsis is this: The Fed means business. It wants to raise rates. Whether that is to give it some extra “dry powder” for when things go south again or because they want to crash the economy, or maybe they really believe that now is really the best time I’ll leave that up to you.

What you should think about now is what does a Fed rate hike mean for me as an investor? For one the dollar will strengthen. Short term interest rates will rise while long term interest rates fall causing the yield curve will flatten like it’s 2006. Yes I still believe there is room for the RECORD LOW long term US interest rates to fall even further. Just look at Switzerland where interests rates last week out to 12 years were NEGATIVE. So please, buy some long bonds before I hit you for not recognizing the most obvious trade of 2015.

The Swiss Jump Out Of The Way Of The ECB’s QE

Just one day after an European court declared Outright Monetary Transactions OMT (aka QE, aka Money Printing) legal, the Swiss National Bank followed up with a shocking move… They removed the Swiss Franc’s peg to the Euro. This incredibly bold move has reeked havoc on the financial markets as the Swiss Franc soared, the Swiss stock market crashed, and commodities bounced higher with oil reaching +5% on the day at one point. To try and counter the new found strength in the currency, the SNB decided to out do Japan and lower short term rates to -.75%. As I write this article Swiss bonds out to 9 years offer negative interest rates!

But why now? It’s been three years since the Swiss pegged their currency to the Euro so why now? The obvious answer is that the Swiss fear what the peg would do to their economy after the ECB launches a new QE program. Just two days ago, a European court declared that Outright Monetary Transactions (aka QE) by the ECB are legal. So Draghi has all the authority he needs to go into the meeting next week on January 22nd and start the new QE program.

I of course remain skeptical that printing money will have any long term positive affects on the Eurozone economies. Short term I expect a bounce in equities but as for European bond yields, I’m not sure. There could actually be a temporary upward bounce in yields like we saw in the US when the first QE programs were launched due to fears of inflation.  Those fears seem to still hold water today as we saw commodities rally hard with gold up over 2% on the day. It appears the market too believes that European QE is all but certain.

Of course there is always the contrarian position that Draghi has been blowing smoke this whole time and if he could have or wanted to do QE he would have done it by now. However, if the January 22nd meeting does pass without the start of the QE program we could see a massive drop in commodities and European equities. Is he really going to risk that? At this point I think not but we’ll see. Of course this is the central problem with central planned economies. A group of unelected people deciding where the entire world should put their money on a daily basis is absurd beyond any measure of logic. This will end so badly it’s almost comical.

Good luck to all the investors out there. May you correctly guess which way the wind is blowing!

Still Waiting For The Bottom In Oil

There’s been a strange consequence in the drop in the price of oil that not many people are talking about – increased oil production. Oil production is continuing to rise even as the price falls which on the surface doesn’t make any sense, so it’s a good thing we brought our superman rated x-ray goggles!

It’s bad enough that US shale companies’ margins have been destroyed by the fall in the price of oil but when you throw in the fact that these are the most heavily indebted companies in the US you start to see the big picture. They need good cash flow to sustain their operations and keep their credit rating high enough to obtain loans in the future to pay off existing debt. So they make up a loss in revenues from the drop in oil price through increased production. They can do this because although the cost of drilling a new well is high the cost of extracting oil from existing wells is still well below the WTI price of $45. Maybe the overall cost per barrel is above the current price but that doesn’t matter because these companies are trying to outlast their competitors.

Source: Zerohedge

Unfortunately, their competitors are not just limited to other shale companies but entire countries. And these countries aren’t in much better shape than the shale oil companies. They too depend on oil revenues to sustain their way of life. So they too will produce more as the price declines.

Source: Zerohedge

What this leads to is a downward spiral in the price of oil. As the price falls, countries and companies desperate for cash are forced to produce more and more in order to stay alive. So oil hasn’t bottomed out yet and it won’t until we see a massive reduction in supply due to bankruptcies in the capital intensive portion of the energy sector.

I am and remain heavily short US energy companies. I’ve been increasing my short position in XLE since the start of the year and will continue to do so. I haven’t been this bearish on a sector since Russian equities in October… and we all know how that turned out.

Gold and Gold Miners Are Set To Lift Off

2014 was a big year. It was the year where we saw long term trends slowly start to reverse. The US dollar strengthened. Oil crashed. Volatility rose. The Fed tightened…And Gold bottomed out.

Ever since gold peaked in 2012 gold miners have been getting the short end of a very long stick. US equities soared while gold miners fell into oblivion reaching lows not seen since the 2008 financial crisis. If you bought back then at record lows you would have made a killing. I think the same opportunity has now presented itself.

The global economy is very fragile and is hurtling towards another crisis as oil plummets and volatility and uncertainty rise. Gold like bonds will see appreciation as people seek safe assets. And only one of those is the true safe haven. I’ll let you guess which one.

As I’m writing this article, gold has rebounded to $1239 while oil is sitting at $45. So even if you don’t believe another global crisis is around the corner, just look at the numbers. Gold miners cost of business has fallen meanwhile the thing they sell, gold, has increased in value. I stated this fact a while back while oil was around $70 in October but it needs to be said again. Gold miners will be THE equities to hold for the coming few years.

FOMC Minutes: Let’s Get The Ball Rolling ASAP Then SLOWWWWW

The Fed talks and the US market rallies. Yesterday marked the third time in as many months when the Fed was able to completely turn the market around. It doesn’t seem to matter what they say, as long as they say something.

The Fed’s newest piece of propaganda and subterfuge is one giant hand to pat the market on the back while it fashions a long jagged knife made of unicorn bone carved by the Hatari Honzo himself and tipped with the alien blood from alien. Yes the Fed is going to stab the market in the back but hey don’t worry about the price of oil. It’s temporary they say. Don’t worry about sub 2% inflation, it’s temporary too. Don’t worry about the US economy, it’s doing fine. We can be patient. We’ll stab the market very gently.

Yeah… but you are still stabbing the market with a alien blood tipped unicorn blade! It can’t handle that and I’m not alone in my thoughts. Just hours after the Fed released the minutes, Chicago Fed President spoke up and said “raising rates at the wrong time would be a catastrophe”. And that’s precisely what the Fed seems prepared to do. They want to get the first rate hike out of the way as soon as possible. That way, with a firm foothold and a calm market they can try and slowly normalize policy. But I have my doubts. Keep your eyes spotted for any flying pigs.