September 1, 2008
I've punched this out tonight, at the end of a holiday weekend and am sending this pretty much unedited. Please excuse any rough edges...
Buy Treasury Bonds
I remain extremely bullish the bond market...Here are a few reasons...If I let myself, I could probably pound out 20 pages on this subject, but know, understandably, no one would read it.
Bonds do move, typically in 10-15 point swings ($10,000 to $15,000 per futures contract), and they have been sitting here sideways for almost a year. As futures are inherently volatile, sideways is never a permanent condition, and the most interesting and potentially dynamic set up I like is a market that has "gone nowhere" for a long time. Bonds are, I believe, ready to go somewhere...and everything I see suggests it will soon be on the upside, with a target somewhere in the 128-130 area.
Inflation is the #1 enemy of the bond market. If for example, you have 6% inflation and a Bond is only paying 5% interest, you are losing money...However, we have just been through the worst inflation in over 20 years, and you'll note on the chart following, Bonds "should" have gone in the tank, but in reality, did nothing but go sideways. To me, the fact they did not collapse (and in fact are now right at their contract highs) is indicative of the underlying strength of this market...Give bonds ANY reason to go up and I think they could go nuts...And one of those reasons might now be that all of those bullish commodity markets are now beginning what well may be precipitous declines, that led by the continuing decline in Real Estate prices, deflation could become an even greater worry than inflation ever was...I could rant about this at length but will just leave it at saying I think prices at the producer and consumer levels have peaked and the inflation figures going forward will be dramatically bullish for the Bond market.
For the past year, as the dollar was steadily falling, you certainly heard the innumerable "expert" references to, "If foreign buyers totally lose confidence in the dollar, they might dump all the US Treasury Bonds they own and our rates will go screaming higher!"...Well, in spite of all that drivel, nothing of the sort happened. The Dollar did keep falling, making louder and louder headlines, and analysts kept warning about owning Treasuries, but again, the bond market never budged to the downside...and if you followed their advice and sold US Treasuries, today you'd be losing money.
I believe there is no safer long term financial instrument on this planet than United States Treasury Bonds. Talk all you want about the USA losing its international economic dominance (I totally disagree), but our financial paper is, in the end, what international investors want when it comes to crunch time...Think about it. Every time there is some sort of international crisis, that phrase, "flight to quality", appears everywhere in the financial media, and what does it seemingly always refer to?...US Treasury Bonds...For a market go down, you need more sellers than buyers. In today's world, with political, economic and stock market turmoil/uncertainty around the globe, I believe there are hoards of ready buyers for our paper...And, in reality, I don't think ANYONE in the fixed income world is even remotely interested in actually selling, i.e., getting rid of, US long term paper. They can yap about selling all they want...but they don't actually do it.
I certainly do not know but I suspect the housing situation has not yet inflicted its worst pain on the economy. I see a good deal of opinion that the economy has "absorbed" the real estate hit but find it hard to agree. I don't think much has changed since I wrote the following back in May:
"I have NO idea as to how far the whole housing debacle will extend but when I see developments full of brand new (year old) totally finished houses with prices already whacked 10-15% and zero traffic looking at them, I can't help but expect real estate prices can do anything but continue to fall...There's one example right down the street from me...$500,000 homes that were finished last summer, 13 of them occupied and 28 still sitting there empty. It's late spring, they've lowered prices by $30,000 to $50,000 a unit and the place is still like a ghost town, not even an agent on the premises. Maybe I'm wrong, but my guess is easily 25 of them will still be unsold come winter when the housing market dies for the year...and those houses won't have a chance to get moved until 2009 when they'll be probably be priced deep in the 300's..."
Even though I know there must be a lot of pent up demand in the residential market (prospective buyers having to sell their own homes, it's been difficult for anyone to move for quite some time now), three months later that development has sold exactly two homes, leaving 26 out of an original 41 still empty. They are all quite nice houses, long finished all the way down to landscaping...but they are not moving...and as we now head towards winter I can't imagine what is going suddenly see them start selling...Kennesaw, Georgia is not the world, but I would think to some worthwhile degree it is an average representation of what is the case all over this country...The bottom line is, the just updated chart of the Case-Shiller Housing Price Index below hasn't shown any sign of stabilizing, and with what I believe will be continuing excessively massive inventories out there (similar to my neighborhood example), I don't see why this should change. Maybe I'm wrong but I would guess there is much more housing price depreciation on the way, and with it, more consumer pain as millions of home owners find themselves owing more on their mortgages or home equity loans than their houses are worth...My general optimistic nature argues against what I think is coming, but I can't get past the idea that all those inventories are NOT going to move at anywhere near their current prices and that there's a psychological negative price snowball rolling that, at the earliest, won't be even begin to slow down until next spring...And with it, hard as it may be to believe, all the bad bank news out there is FAR from over...and I guess the downward pressure on the stock market as well.
DEFLATION SHOULD BE MORE OF A WORRY THAT INFLATION?
THE BOTTOM LINE IS I DON'T SEE HOW IN HELL ANYONE SHOULD BE EXPECTING ANYTHING LESS THAN SHARPLY LOWER LONG TERM INTEREST RATES. MAYBE I'M WACKO BUT I SEE THE 30 YEAR TREASURY BOND, CURRENTLY YIELDING 4.41 %, GETTING AS LOW, AT LEAST, AS 3.75% WITHIN THE NEXT 6-9 MONTHS...AND AS I SAID AT THE BEGINNING OF THIS TOO LONG HARANGUE, TREASURY BOND FUTURES WILL THEN BE, AT LEAST, SOMEWHERE IN THE 130 AREA..
I want to be all over the Bond market on the upside. With them sitting here on the old highs, they are in the perfect place to put on "units" of two calls to every put, in that, from here, my guess is they either take off somewhat vertically...or they get rejected, and fall off the 5 or so points probably necessary to recoup 100% of what it would cost to own each unit.
Still Shorting the Soybean Complex
Especially Soybean Oil
Quite understandably, it looks like the Corn, Wheat and Soybean markets all needed to "bounce" a bit for the past few weeks as there has been a lot of talk about, "What if it doesn't rain in the mid-west?" or "What if we get an early (crop killing) frost?", implying that all of these markets could go shooting off into the stratosphere again. I've bought in to that sort of stuff more times than I'd care to admit (and lost money) and am sticking with the idea there are MASSIVE crops out there, we are still headed hell bent for harvest, and I believe there is no way Soybean farmers are going to driving up to their local elevator in November and be handed anything close to today's $13.50 a bushel price...I am sure there are people looking at the way these markets have dropped and are thinking, "They MUST be a buy", but I'll go back, one more time to my example of wheat earlier this year...In May, Chicago Wheat was trading at over $13 a bushel and the story was it would never stop climbing. In general, with sentiment so crazy bullish, farmers didn't lock in those prices when they could in May, and two months later, at harvest, as they all came out of the fields, when most of that wheat had to then be sold...and they ended up taking $7.50...I think it will be the same with Soybeans and Corn come their respective biggest harvest months of November and December.
As I still see Soybean Oil as the most inflated part of the soybean complex, this is the market I am sticking with as my primary vehicle...I still expect to see it, minimally, in the low 40's and see this most recent 4-5 cent rally as an opportunity to establish new short positions.
Still Shorting the Cattle Markets
Cattle are still near record highs. I've been longwinded enough already so all I'll say is I don't think the current economy will support even higher beef prices than we have now, and cattle prices have nowhere to go but lower, and perhaps very sharply so, over the next six to nine months...I'll also add that all year I have seen nothing but bullish, bullish fundamentals being cited in the cattle market, both as to supply and demand, and suspect that this ultra bullish sentiment has led to a situation where there are many more animals, and maybe a lot weaker demand, than most people in the business are anticipating...and the end result will be one of those "endless" sell offs that are so almost common in the meat markets.
Still See Crude Oil Sliding
I know there must be legions of speculators thinking, "That crude is going to rally big from somewhere in here", but I suspect the quite the opposite may be coming...that the roughly $35 totally unexpected sell off (think back to how nutso bullish everything was just one month ago), after a brief recent pause, is about to accelerate again on the downside. Here we've had several hurricane scares, with the Russian invasion business in Georgia, and still Crude has stayed on the soft side when six months ago this market would have been rallying $5-$6 a day? I think the lack of upside moves maybe speaks volumes about the inherent weakness of this severely overpriced and speculatively inflated market...and still think the first real stop could be under $90...
I never forget that the futures markets are constantly swinging between extremes and are never at equilibrium (I don't care what any analyst comes up with. I don't think there is a "fair" or specific value for anything in the futures markets).Those extremes can exist in price, such as Crude's last blast straight up from $90 to $147 (a 50% increase!) and/or in emotion, where, as it was just a month ago, we had some supposed geniuses talking about $8.00 gasoline (!)...My point is, this sell off in crude has taken place fairly "quietly", and my feeling is we have not even begun to approach the next extreme, that of the BEARISH variety where the whole analytical world loudly declares, and certainly with a host of supposedly sound fundamental reasoning, "We've changed our minds! It's headed for $50!!!".
But who knows about any of this? To some extent, luck has been with me for a while, but you can be assured, as strong as my opinions may be, I do know that I don't know...More than anything, succeeding in these markets is more about risk management and being able to stay in the game when you are wrong (which you are often going to be), which is why I'm always preaching in favor of the so ineloquently named, "2 and1", thus enabling you, when you are lucky enough to be right (which sometimes we are) to actually make some money, which, as a function of the ridiculous leverage of futures, can occasionally result in truly "giddy" type percentage gains.
Give me a call if any of this interests you, or if you have ideas of your own you'd like to explore...