Live By The Yen Die By The Yen



For market participants hoping for well coordinated intervention by central planners, 2016 has been a disappointing year. It’s also been an incredibly frustrating year for my sanity.

Whether it’s the back and forth flip flopping Fed, or the Japanese central planners who promise the moon and deliver next to nothing, I’m starting to wonder how much longer the markets are willing to tolerate this incessant teasing by central planners.

Recall that back in January, when the BOJ unleashed NIRP, the market’s immediate reaction was pure fear and the Yen actually rallied sharply. So it’s important to analyze the market’s reaction to any further shenanigans from the Keynesian Nirvana seekers also known as the Japanese central planners.


The best case one hears today is that “they’ll manage it”. Meanwhile, the Yen has whipsawed about more than a Michael Bay action film as the Japanese Government rushed together another stimulus package, this one according to Abe is over 28T Yen.

Size does matter, but it’s also a matter of how you use it. And only 1/4 of the package will go to actual spending over the course of a few years. Sure the deficit that has been negative for over 2 decades will expand, but it will not expand far enough to match the ridiculous 80 Trillion Yen/year bond buying program the BOJ has had in place for over a year now.


Once again it all comes back to the simple problem of supply and demand. The bank of Japan’s limitless demand is running into the problem of a limited supply of bonds. Back in May I wrote:

Thus the amount of JGBs truly available for purchase are smaller than people realize, which magnifies the BOJs current conundrum: Where are they going to find the bonds?

The answer is the Japanese government should issue a poop ton of debt by expanding the deficit even further with the BOJ monetizing every last bit. Unfortunately with Japanese government debt to GDP at +220%, it seems silly to think that the answer to Japan’s problems are for the government to issue even more debt.

With such a high debt level and such a large balance sheet, both the government and the central bank respectively have become limited in what they can do without creating doubt in their abilities to control the situation.


The BOJ is aware of the perception that it may be reaching its limits, which may be why the Japanese Government “reached” for the reins.

It is now apparent that the Japanese government was trying to force the Yen lower through a meaningless gesture of a weak stimulus package which has underwhelmed market expectations. The response was quite expected – a rallying Yen crushing the hopes of Japanese central planners.

How long before they are forced into Helicopter money remains to be seen, but according to Abe’s bleak opinion we may not be far off. From the May G7 summit,

“The global economic outlook is as grim as it was after the Lehman Brothers crisis in 2008, Shinzo Abe claimed on Thursday, as the Group of 7 revealed its stark divisions on economic policy.”

That’s a bold statement, to essentially say the world is on the edge of financial collapse. It’s arguably even bolder to not deliver on a significant stimulus package when one believes the risks are that large.

His fear is obvious, whether he is right or not remains to be seen. In the meantime we can all watch together as the strong Yen continues to undo all of Abe’s and Kuroda’s hard work.

Financial markets, especially these days, seem to be all about perception. Fortunately, not all countries are bound by the same perception that has shackled the Japanese central planners.

Take China for instance, where in the first quarter of this year the central planners launched a stimulus package of 10% of GDP over the course of just 4 weeks. Japan can’t even do a 5% stimulus package spread over a few years without drawing negative attention!

China of course, is the country that while simultaneously suffering capital flight has also experienced one of the fastest growing and largest debt bubbles in history over these past few years, and yet they can get away with massive stimulus packages. I can only imagine Abe’s outrage to such a ridiculous double standard.

Which brings me to the CNYJPY, an important but virtually unnoticed cross rate. The Yuan has been falling against the dollar these past few years, while the Yen has been rallying against the dollar which has led to very impressive decline in CNYJPY. So much so that the 50% fib retracement level off the 2012 low is now resistance going forward. ‘

Given the current pressures facing both currencies it seems hard to believe that this current downtrend will reverse. If CNYJPY crosses the 61.8% level, we should expect more risk off and deflationary pressures going forward.

It’s hard to see any of these events as bullish. And when you throw in the 1.2% US Q2 GDP growth, it makes me want to reach for the “fire everything button.” Instead, I will use this time to build my short position further via the purchase of +2 year duration puts on the S&P500.




So You Think You Can Hike

Sometimes it can be difficult deciding what to write, and other times the Fed hands you your next post on a silver platter.


Thank you WSJ.

Emboldened by the recent quarter of decent GDP growth, falling unemployment, rising inflation and above all else a soaring S&P 500, the Fed says its ready to hike… just not right now.

“Officials are almost certain to leave rates unchanged when they meet July 26-27, according to their public comments and interviews with officials.”

I’ve already said my piece on the importance of a Fed rate hike for the July meeting.  I believe it is their last chance to hike.

If they truly want to hike, waiting is a massive miscalculation. The data will not be this supportive again.

A large portion of this stock market rally can be attributed to talks of helicopter money arriving in Japan. The Yen has sold off, US credit spreads have fallen, and the market has convinced itself that everything is fine.

Except everything is not fine, just look at the US’s umbilically tied partner in crime – China.

China FAI

At this rate, private FAI could be negative by as soon as July, although I have my doubts we’ll ever “see” a negative number. But according to Worth Wray, that’s not even the worst part.

We are witnessing what happens when the central authority begins to lose control. Much like the US in 2008, the Fed cut rates to zero and still the economy collapsed. During the expansionary phase of a credit cycle the central planners have a lot of control, but it becomes incredibly difficult to stop gravity once it has taken hold.

This also comes at a time when China’s house price inflation appears to have peaked for this cycle. The tier-1 cities have certainly rolled over.

Meanwhile the dollar is rising off its bottom from early may.

Any further strength in the US economy could accelerate the dollar’s rise and put further pressure on the Yuan which hit a 6 year low against the dollar yesterday morning.


All of this comes at a time that China’s corporate bond market is starting to freeze up. This comes after making a 9 year low in January.

China Bond Spreads

Defaults in China are rising quite rapidly. Halfway through the year and we’ve surpassed the previous two years of defaults combined.

These defaults come at a time when short term financing via Wealth Management Products (WMPs) has absolutely exploded. According to Bloomberg:

“In 2015, China’s financial firms raised 158.4 trillion yuan ($24 trillion) — equal to about 230% of GDP — by issuing wealth-management products (WMPs). The amount of WMPs outstanding at the end of the year was 23.5 trillion yuan. The gap between those numbers reflects the fact that most products have a maturity of a few months so funds are rolled over, perhaps several times, over the course of the year.”

China’s financial firms cannot afford a panic in the bond market. They’ve become too dependent on WMPs at a time when bond defaults are rising, and the private sector is losing faith in the economy.

It won’t take a large hiccup to upset this fragile apple cart which makes it difficult to say how long this can truly last. Using 2008 as an analogue, subprime borrowers were defaulting on their first payments back in the spring of 2007 but it wasn’t till the fall of 2008 that the economy truly started to implode.

To wrap up, the financial plumbing of China is under tremendous stress. Any Fed tightening or dollar strength will exacerbate said stress. So the Fed can talk about hiking, which will push the dollar higher, but they cannot actually hike, because they risk setting off the Chinese debt bomb.

US risk assets can and have certainly headed higher on the hopes of a stronger US economy, which is why I recommended back in May buying S&P500 calls above the all time high, because as I put it:

“Firstly, I would like to reiterate the great risk reward opportunity S&P call options provide over the near term. No one thinks we will hit new highs on S&P which makes call options above that level so cheap and a great way to hedge this bullish scenario.”

And maybe I’m wrong, maybe low oil prices combined with a healthier oil sector (now that we’ve had a bunch of defaults) will push the US economy into a higher gear by the end of this year. With the rest of the world struggling to grow, it’s difficult to imagine the dollar not breaking out of its 18 month trading range and we know what that means for risk assets.

So best of luck to our Fed officials. It certainly looks like they will need it.


When Micro Met Macro


It was a hot summer day. The Global Warming Gods had been working their magic on the north shore of Long Island. The dying summer breeze left the air thick and hot. It smothered young Maggie the black haired mutt, who lays trapped on the floor.

Meanwhile, the Klendathu Capitalist, had fared no better. He struggled to maintain his focus. His long blonde hair was thick with sweat. The information was starting to blur in his mind. The chart on his computer was inseparable from the last few.

I need a break, he thought.

As he was getting up he looked back at the previous few charts and it hit him. They were all the same chart… except they were different.

What follows is the story of When Micro Met Macro:

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Four separate sectors: Lithium, Fertilizer, Iron Ore, and Solar Grade Silicon, with four very similar cost curves. Notice the location of where Chinese companies fall on the scale – the high cost end.

Chinese companies are inefficient. This is not news. China’s zombie companies are a well known problem. They were profitable during booming demand times when prices were higher and most importantly when wages were lower.

Since 2000 wages have more than tripled, which has put considerable pressure on Chinese company margins.

China Wages

Simultaneously, the Chinese Yuan has been rising in value over the last 16 years, which has further hurt Chinese company competitiveness.


I am willing to bet that China’s zombie company problems extend far beyond these four sectors, but the issue is the same – the costs are too high.

There are many ways to skin a cat, just like there are many paths to discovery. The Chinese Yuan Devaluation is no different, and this is just another way of arriving at the same conclusion.

Unless prices dramatically rise into an oversupplied market (unlikely), the CCP will be forced to let the Yuan fall a significant amount. This will reduce the cost of labor, and the debts these Chinese companies hold. With a weaker Yuan, China will save some zombie companies and even some of the healthier companies that have struggled to survive in such a harsh environment.

The point I’m making is that from this perspective a Yuan devaluation makes sense. And we know what a deflationary event like a Yuan devaluation means for global risk assets. It’s not hard to position for this outcome. Buy treasuries, gold and short risk assets.

It’s the other side of the trade that isn’t as easy to hedge. What happens if the CCP doesn’t devalue the Yuan and can successfully delay the inevitable for another few years?

I’m quite skeptical of China’s ability to keep the game going for another year, but say I am wrong. Say China keeps the credit pumps flowing into these companies for two, three even five years without losing control.

In that case, I want to be in the strongest growing sectors of the global economy. If nothing bad happens, I want to be in the sectors or plays that will explode.

And that something as I mentioned in a previous post is the coming energy revolutionAlthough the time horizons do not perfectly mesh, rarely do I find a way to hedge my global macro thesis with long term technological trends.

Unless prices rise, these Chinese zombie companies will go out of business. And even if prices do rise, they would have to rise considerably higher into an oversupplied market, which is hard to do.

Even if price does rise it will likely not be sufficient to save the inefficient debt heavy Chinese companies. For reference look at oil and gas companies which are on the verge of bankruptcy even after the price of oil almost doubled.

Thus if prices remain the same or fall, production/supply will be cut. In the important energy markets, rising demand coupled with falling supply will create a sharp turn around in price. The old adage “the cure for low prices is low prices” holds again.

Seems obvious, and maybe it is, but you also have to pick the right sector. Which brings me to Solar Grade silicon metal (SG Si), or the silicon used to make solar panels.


The current process for making solar grade silicon, the Siemens Process, consists of multiple steps, large amounts of energy and toxic chemicals.


Back when the price of Silicon was 3 or 4 times higher than it was today, it made sense to scale this process up.

Solar Grade Silicon

No one expected silicon metal prices would fall this much. Meanwhile demand is rising… quite rapidly.


And yet the price is not rising enough to give reprieve to the underwater companies.

Silicon Opex

It’s unclear how some of these companies will survive. Judging by demand growth it will take at least another 2 years before demand comes close to current capacity. In the meantime, a large share of these companies will continue to lose money. Considering, Chinese cost of production has been over the price of SG Si in China since 2012, it’s not clear how much longer these companies can last.

But it gets better, because if you give an engineer enough time to solve a problem, he OR she will solve it. As I stated earlier, the current process for producing solar grade silicon is inefficient and outdated.

Long term, innovation will completely change the landscape of silicon production as companies like Silicor Materials develop and deploy new non-toxic less capital intensive processes to produce solar grade silicon metal.

Unfortunately, Silicor Materials is not a publicly traded company. But there does exist another pair of companies, Pyrogenisis Canada Inc and Uragold Bay Resources (DISCLOSURE: I am a shareholder of both) that has developed its own one step process for converting quartz into solar grade silicon metal.

These companies should be able to undercut the current competition in a growing market. It’s hard to imagine a more bullish set up.

I haven’t been “doing macro” long, or at least not very well, and rarely have I seen a way to hedge my macro views with a bullish technological trend. Silicon is still the most expensive component of the solar panel. As new technologies are adopted dragging down costs, solar’s adoption will grow.


But silicon isn’t the only space I’m looking at. Graphite, another resource almost completely dominated by Chinese production is a similar space ripe for innovation.


Of course you cannot mention graphite without mentioning graphene, which is arguably the most important material to be created in the last 100 years and that’s including anti-matter. The unique 2-D material may soon be mass produced as a byproduct from high grade graphite mines.

The impacts this material will have on our lives is practically limitless and beyond imagination, but the time horizon is rapidly approaching. Within five years we could see mass produced graphene appear in products all over the world.

Once again, bringing micro back to macro, silver is also a key component in solar panels. Although it should be noted that solar panel demand for silver makes up for less than 10% of total silver production.


Not all of the knock on effects of the booming solar industry have been listed. I failed to list the revolutionary potential solar power promises for emerging markets with poor grid infrastructure in Africa, South America, and South Asia. Or the more obvious death of coal fired power plants, and the potential rising demand for nuclear power as the major player in base load power.

I’m going to state the very obvious, but widely ignored: Technological trends, not just solar power, will shape the world and bring sustainable growth at time when growth has never been more paramount. It’s important to recognize such trends and invest in them. The number of positive knock on effects make it that much easier to stay diversified geographically, and politically as well giving the ability to hedge against bearish macro views.


DISCLOSURE: I own shares in Urabay Gold Resources (UBR.cve) and Pyrogenisis Inc (PYR.cve) as well as Talga Resources (TLG.asx) and the commodity silver.




Terminator 6: The Bull Market

Did anyone else see the last terminator film starring Daenarys Targaryen and the Governator? Terminator Genysis? No? Didn’t think so. Don’t worry, you didn’t miss much. Besides this bull market makes for a much more interesting terminator than the latest CGI incarnation I saw in Genysis.


The T-3000 is no match for the SPX-2150. It doesn’t matter what you throw at it. Brexit, insolvent European banks, China’s slowdown, shale oil implosion, nothing will take it down. It just keeps coming! This cybernetic creation of algorithms, central banks, and limitless stimulus seems virtually indestructible right now.

The recent Japanese elections have provided a nice spring board for the risk on environment. USDJPY rose from over 5% in less than four days on hopes of helicopter money. I remain skeptical on the long term viability of such a plan.

Meanwhile bears are on the verge of capitulation. At 2200, a key technical level, investors and traders could be induced to join the party.

The bears, trapped and surrounded like the Allies at Dunkirk, are in dire need of a miracle. Just remember, the night is always darkest just before the dawn (cut to 0:43) .


Fortunately for the impatient among us, now that the S&P has broken out of its 19-month trading range, the battle for the dawn will most likely be decided sooner rather than later.

I’m not going to launch into fears of a serious melt up in stocks. I don’t think we get that nail biting face ripping rally without a rise in bond yields, and for now it seems like bond yields have a ceiling that is constantly falling.

For the second day in a row, the S&P closed at all time highs. Which is a little strange considering, earnings may have fallen for the 5th consecutive quarter.


Perhaps even more interesting, is this belief that the earnings recession has bottomed. But if you look at the Atlanta Fed’s GDP now tracker, you see the cyclicality of GDP growth.

A very keen observation from Raoul Pal. US GDP growth is cyclical and rolling over. That certainly doesn’t bode well for a magical rebound in earnings. And even with the gang busting 287k jobs report, the US job growth continues to slow.


Slowing employment growth and a weak growth GDP quarter could weigh on oil which seems to be breaking down at least from a technical aspect.

When the falling earnings story first started gaining traction everyone blamed oil. Take out the oil and gas sector and everything looks great they said. It’s ironic that this sector is now holding up US equities. A drop back into the 30’s would likely reignite the high yield bond sell off we saw back in January.


I’m not saying that’s going to happen, but the S&P is priced to perfection. One small step, and the fall is staggering. Just look at the recent rally from a perspective of volume.

In the end, when you pull back the artificial organic material, you’ll see the SPX-2150 is much weaker than thought. It’s had the kitchen sink thrown at it and has kept going which has fueled speculation that this market is indestructible, but in reality it’s barely limping by. Going forward, the key short term indicators to watch are USDJPY, US treasury yields and oil.


Investing in Innovation: Battery Boom


Ask a bear what he is and he will tell you, “I’m a realist.” No one wants to be bearish let alone admit it. Being bearish is the mental state of mind equivalent to a socialist government. Simply, it taxes you.

With each sand castle global leaders build, you pay the realist in you another fine. To think about the world in such simplistic terms can be enlightening but also painful. Especially when the mistakes are this large and this obvious.


As a person who has witnessed countless kingdoms of sand built in front of a rising tide, I can tell you that I’m tired of being bearish. I don’t want to have 60% of my portfolio in gold and US treasuries. I long for the day I buy into an equity market that I BELIEVE is headed higher not because central banks dictate so but because it is supported by rising technological, demographic, and economic trends.

Alas that day is not yet here. As a self described realist, I am forced to make the best with what I’ve got, and what I’ve got is a hill of batteries. Lithium ion batteries to be specific.

These high energy density batteries have received much of their attention due to Elon Musk’s flamboyant comments about taking the entire world’s supply just to satisfy Tesla’s demand. But readers who stopped at the page on electric vehicles (EVs) have missed most of the story.


Which is why the market’s reaction to Tesla’s bid for Solar City was so harsh. Tesla is no longer a car company. With the world’s largest battery factory, Tesla has become a battery company. It’s potentially a great pivot for a company that makes less than 100,000 cars a year at a massive loss.

Car manufacturing is a low margin business with future demand slowing due to technological and social trends, but batteries , where the demand rises as the costs fall, is a high margin business that is growing rapidly.

Now I’m not opining on the viability of this transition. I’m just pointing out that Elon Musk who is a smart man with inside knowledge appears to have staked his future on batteries and not cars. That should be noted.

“Entering 2016 GM said its cells cost $145 per kilowatt-hour, and by late 2021, they could be at the $100 mark.”

The cost of lithium ion batteries is falling while the efficiency and energy density are rising. It’s a beautiful combination and as the trends continue, the uses and demand for batteries will explode.

Grid storage will be the largest market for batteries. Already smart batteries can help control the flow of power through the grid during peak power demand which dramatically cuts costs. But for the past five years, battery technology and its adoption has lagged behind both solar and wind power.

The demand for grid storage is already there, but only now are batteries reaching the point where they can technologically satisfy that demand. As battery tech improves the demand from grid storage will rapidly increase.

Batteries will also have a positive impact on the viability of both solar and wind power as well. Wind and solar are not viable as base load power, and I’m not saying they will be in the next 5 years, but in an increasing portion of the world, the combination of solar or wind power and a large battery will be more than sufficient for household needs.

The battery story seems like a great one, but these days stories rise and fall on the whims and demands of the Chinese people. Fortunately for this story, the China’s rapid growth over the past two decades has only been matched by its capacity to pollute.

Since social stability is key in China, massive strides are being made to placate the growing middle class that wants to live in a clean environment. As a result, no country on earth is investing more into green technology and infrastructure than China is.

Obviously this has led to inefficient uses of capital and some 30% of China’s wind power is sitting idle in the south west. But the point is that China is shifting its demand. And the materials it will consume over the next twenty years will look different from those of the last twenty years.

There are many “new age” metals that will benefit from technological trends and right now lithium is the flavor of the month. Humanity has been a carbon powered race for over 100,000 years but as time progresses, and people expand their horizon they will discover that Lithium is not the only character in this story.

Currently lithium makes up about 2-3% of the overall battery’s cost. That could rise slightly as the demand for such a tightly controlled metal explodes, but it won’t drastically affect the overall cost of the battery.


From a weight standpoint, lithium ion batteries should really be called cobalt graphite batteries. Per weight, there is more than 10x as as much graphite than lithium in a lithium ion battery.

When it comes to graphite, China is the world’s largest producer, making up 70% of global production, in a market that is currently oversupplied. A lot of this production is done by small unregulated highly polluting companies. Needless to say, China is in the process of consolidating and cutting these inefficient means of production. Thus overall supply is falling in to a market that is seeing demand rising rather dramatically.

There are nuances to every market and the graphite market is no different. Although currently oversupplied, the graphite market is a tale of two purities. The low end market is oversupplied but the high end market which is used in batteries is not.

High purity graphite is not only expensive, but is dirty to make, once again contributing to the hesitation investors and governments associate with this space. A very large graphite resource out of Mozambique will come online later this year further adding to the oversupply and complicating this market.

Just because the graphite market may not be as clear as the lithium market doesn’t mean there aren’t some hidden gems to be found. Just like hydro-fracking technology was to shale, resource companies are finding new and more efficient ways to extract and manufacture high purity new age metals. Graphite, lithium and even silicon are benefiting from these potentially revolutionary technologies.

For example, solar grade silicon is currently mass produced using technology from the 1990’s. Lithium brines are still being extracted using the sun to dehydrate water. The technologies for extracting these metals has lagged the technologies they go into. But that is changing, and that is where I am investing.

For the purpose of brevity, although I’ve now run over 1000 words, I am cutting the post here. In the coming weeks I will dig a little deeper into the specific markets for some of the new age metals such as graphite and graphene, silicon, and uranium. If you would like to know more, stay tuned.

Best Case: European Bank Bailouts

The shroud surrounding the European banking system is fading. It’s not pretty. No one ever said it was. A lone knight promised he would defend it to his last breath and no one dared challenge him.

For four years he remained unchallenged, but now the deflation dragon has come and it is not afraid. It wants a sacrifice, a fine Italian bank that has never defaulted – a bankruptcy virgin.


The lone knight, appears no match for the mighty dragon. He has slain countless dragon children but no adults. He will need help if he is to withstand. He must call on his Queen to send in the helicopters.


But the Queen refuses. The Dragon changes its mind. Now it wants all the Italian banks, pure or not.

The lone knight begs the prince to rally his personal guard and stand by him. So the prince gets his men, they dress in fire proof suits made from the silver-black hair of the under belly of Swiss unicorns.

In the barracks they are set upon by the Queen. She won’t let them rally to the lone knight’s side. He must earn his name. He who has lived by his sword must now die by it.

There was never any question. If confronted the lone knight knew he would fail, but he believed he had to try. Someone had to do something he thought.

He now trembles before certain death. Out of forks in the road of destiny, he walks the straight path to the dragon.

A whirlwind of smoke and fire buffet the lone knight. His shield melting, his lungs wheezing, his skin roasting, he presses on. On presses he, who must, because he has to.


He chants the words in his mind.

On presses he, who must, because he has to. On presses he, who must, because he has to.
On presses he, who must, because he has to. On presses he, who must, because he has to.

It powers him, driving him through each excruciating step towards oblivion. He sees the edge but can’t turn back. Not now. Destiny holds him by the strings.

It’s an out of body experience for the lone knight. Constantly alone and living in his own mind he now sees himself from the outside for the first time.

The lone knight’s eyes betray him. He has no armor. There is no sword. Just a man in bright colored tights and matching jester’s hat. The lone knight is a fool.


He watches the fool cower underneath the mighty dragon, its head coiling ready to strike. The hint of a smile on the beast’s face chills the fool to his very soul.

But then…

The beast’s face explodes. 3 million rounds a second of depleted uranium .50 caliber shells rip the dragon to pieces. It’s over in seconds.

The smoke, and dust clear as the 27 EU issued helicopters land in a circle around the fallen dragon. The fool remains, shivering, his soul returned to him.

The Queen steps out of her helicopter, escorted by half a dozen real knights draped in gold embroidered white cloaks.

They surround him, their tall statures blocking out the sun. They part for the mighty Queen.

“Lift him,” she commands.

Much to the fool’s dismay, his injuries are not considered as the knights pull him off the ground. His raw skin tears under the grip of their cold gauntlets.

Now eye to eye with the Queen, she looks at him, hard and unflinching like she’s trying to read the fine print of a royal decree. After a moment, she smiles.

“You will share no part in this victory. It was I who saved the kingdom but at great cost. A door that cannot be closed has been opened. On the other side of that door, dark and powerful outcomes exist. Outcomes we cannot even hope to control, but must still overcome. There will come a time when you will pay for your foolishness, but not today. You will go back to pretending that you are a knight, but from now on, you will always know what you really are. A fool. A fool who thought he was a knight.”


And that is my best case scenario for the European banking system.

Italian banks cannot be allowed to fall. They are systemically important banks. Italian debt holders cannot be wiped out. There’s too much leverage in a fragile system and if the credit cycle swings down, it will swing down devastatingly hard.

If one Italian bank fails, then another will fail, and then another and then a German bank , and by the time Germany comes to the table every bank in Europe will be closed. That is why the best case scenario is for immediate action by the ECB at the permission of Germany and the rest of the EU.

If they act now, and bailout the banks, effectively wiping the bad debt off their balance and by the end, the amount of Euro’s required will number in the hundreds of billions if not trillions, but Europe may finally be able to grow again. Of course that last part is a ways away and we should worry about the more near term impacts of European bank bailout.

The first effect of a large systemic recapitalization of Europe’s fragile banking system would be a dramatic drop in the Euro. The inverse of a falling Euro is a rising dollar. A dollar that would put pressure on both the Yuan and China’s own fragile banking sector. The consequences of this chain reaction alone are horrifying.

But let’s not forget what risk assets would do (are doing right now) in a European bailout environment. Capital would flow into the dollar and US treasury yields would fall even further. Falling global rates push up gold, thus gold should head higher as well in the face of a rising dollar.

I’m not sure what US equities do in all of this. I’m short the S&P, which obviously hasn’t done well (new intraday highs as of this writing), but my mediocre instincts tell me a strong dollar and an uncertain investment environment will not be net positive for US equities that are near all time highs.

The fact that the S&P continues to make new highs led by defensive sectors and FANG is not bullish.This should be an obvious indicator that capital flight from incredibly fragile economies is flowing into the US. It is not a sign of faith in the US economy but a sign of fear and uncertainty in the rest of the world.




EPIC Collateral Short Squeeze: Governments’ and Central Banks’ Magnus Opus


Much has been said about the quality of the cooperation between central banks and governments. One tightens while the other eases and so on and so forth. These petulant children have seesawed their way through the “post” crisis era for far too long.


The mechanical disconnect between their incongruent policies has become so deafening that it is difficult to verbalize. Instead I must ask you to look. Look at the sovereign bond markets of the world. Look at the rates. Look at their trajectory.

What do you see?


Record low interest rates in every major developed country in the world. From Australia to France and from the US to the UK and every place in between record low bond yields continue to plummet with no signs of abating.

Before I continue, I must bring this back to our petulant little kids who appear to have made a very big mess in the collateral markets.


Banks, pension funds, institutions and insurance companies used to be able to count risky assets as collateral, but since the crisis governments have regulated away this practice. In essence, the governments shrank the overall pool of good collateral and forced them to hold more government bonds, which deceased the liquidity and availability in the government bond markets.

Unfortunately for us, governments are about as accurate as a Salvador Dali clock and after decades of fiscal profligacy governments suddenly found religion and decided cut deficit spending which further reduced the already shrunken supply of good collateral.

Central banks then went in and bought a lot of the remaining debt, once again shrinking the pool of available good collateral, drying it from a once vast lake to a now empty crater.


Then all of a sudden…

BOOM! Brexit!


This cherry lands on top of the proverbial three scoop sundae delight. The plucky underdog who came from a poor house in a rough neighbor on the wrong side of Leeds. No one gave this guy a shot. But damn did he show them.

So now the world is in a “risk on” environment. Everyone is running for the exit, searching for safety but finding a barren desert with scattered fat central banking fish helplessly flopping in the dried pools.

The result is a massive supply and demand imbalance, with prices going one way. Bond yields around the world are accelerating into negative territory.

We live in a world where people buy equities for yield and bonds for appreciation and as bond valuations sky rocket despite underlying fundamentals, the game of the greater fool approaches its climax.

In light of these recent dynamics it seems prudent to entertain the possibility of a blow out top in sovereign bonds.

First, the psychological impact of crashing rates could become a self-fulfilling prophecy. As more and more people cram into bonds yields will fall and the global economy may actually start to believe what the rates are telling it – there’s a crisis brewing.

Try to imagine what equities would do if the US 10 yr dropped below 1.00% after falling 70 bps in under a months time. What the heck does the SPY look like in that environment? Do you think it’s still at 2100?

How does gold behave when Japan, Germany and Switzerland can’t muster up a positive yield between the three of them?

What happens if we have a huge snap back rally in yields? What if the game of the greater fool ends quite abruptly? People awake from their foolish trances and start selling but with French paper negative out to 9 years, this sell off is incredibly steep. Potentially steeper than the rally itself. Trillions in losses pile up quickly and this bond market volatility now spreads to other asset classes.

The number of outcomes, and the negative convexity to each of them is worrying. Based on the incredibly foolish excitement this bond rally has generated, I believe that people are not prepared for the consequences.

In light of this revelation, I further added to my S&P put position while holding my gold and treasury holdings steady. If you want to wait for the S&P to break 1800 be my guest but at this point, I’m done adding equity exposure and am looking to trim what parts I can.


Et Tu Italy?

Italian bank shares hit new lows after plans for a $150B bailout leaked. Deutsche Bank isn’t far behind. This is a not paper over situation here. #BankHealthMatters.

The EU is structured in such a way that Italian bond and equity holders have to take a loss before there can be a bailout. Which doesn’t sound SO bad, a bunch of Italians take a haircut then the ECB comes in and papers the rest over.

Except, virtually Italy’s entire banking system, with NPLs at 18 %, is in dire need of a bailout. If people start taking losses on their bonds or their deposits, others will panic.

The average person believes the government has their back in these matters.“Banks are complicated murky institutions but the government knows what its doing,” they’ll say.

What they really mean is that the outcome if the governments fail is so horrific and destructive that they don’t want to think about it. They don’t want to even entertain the possibility of what that would mean for their lives. And it’s normal. It’s natural. It’s a human response to shield one’s self from unnecessary pain especially if you don’t think that pain will ever happen.

Unfortunately, the Italian banking system is an incredibly unstable and interconnected ball of debt and if one bank is forced to do a bail in, others will follow and eventually the average person’s unimaginable nightmare becomes a reality.

And that’s how this gets ugly very fast, because in a crisis, people are forced to make decisions in the very environment they were too terrified to even imagine.

Meanwhile, the most concerning trends continue to flash red. I say that in almost every post, but right now they are inescapably bright, like I’m trying to drive at night with a dozen flash lights on in the car.

  1. Surging Yen – USDJPY 101.77
  2. Declining Yuan – USDCNY 6.67
  3. Gold and Silver hit new multi year highs
  4. Falling interest rates hit record lows – US 10 yr 1.38
  5. Falling EU bank stocks hit record lows
  6. Outperforming S&P 500 that can’t break to all time highs.

The last one is both new and more abstract. The S&P 500 is displaying RECORD out performance against all other developed equity markets.


And yet, the S&P has failed to break to new all time highs. Think about that. The US stock market is out performing the globe at a level only seen once in the previous 100 years, but the stock market actually has gone no where. The entire out performance is due to a crashing global equity markets. US equities remain the last man standing, but I fail to see how this is a bullish signal.

If anything, the buoyant US equity market seems to be giving bulls and more importantly the Fed a false sense of confidence. I look forward to taking advantage of this mistake.


US Treasuries: Squeezing Blood From The Stone


I’m hosting my best friend and roommate of five years’ bachelor party this weekend so unless another major financial shock happens I will be pretty quiet over the next few days.

With that said I’d like to mention that US 10 and 30 year treasury yields hit a new all time low today. With the entire Swiss yield curve out to 50 years, I believe there’s a lot more blood to squeeze out of these stones.

In short, US treasuries beat US stocks to new all time highs.
Don’t say you weren’t warned.

“I reiterate my love for long term US bonds. No way are we anywhere near the bottom in yields. I continue to think we will hit record lows on the 10 year bond later this year.” – February 8th, 2016…/the-market-discovers-…/

“Treasuries still remain an amazing bet and I’m still amazed how many people believed the Fed would be successful in raising rates.”
– Jan 20 2016…/slick-thoughts-a-shar…/

“Long Treasuries – Deflation is great for the dollar. Times of Crisis are even better. Crashing Commodities are even better for long term rates.”
– August 24th 2015…/the-end-is-nigh-china…/

“Yes I still believe there is room for the RECORD LOW long term US interest rates to fall even further.”
– January 20th 2015…/more-confirmation-fed…/

I think you get the point.