Research


Eddy Elfenbein recently put forward a simple model relating gold prices and interest rates:

The key insight is that†Gibsonís Paradox†never went away. It still exists, just in a different form. I got this idea from a 1988 paper by Larry Summers and Robert Barsky, ďGibsonís Paradox and the Gold Standard

Where I differ from Summers and Barsky is that I focused on short-term interest rates while they focused on long-term rates. Well, with Operation Twist we got a perfect test of whoís right.

The Fedís new plan is to sell short-term Treasury bills and buy long-term Treasury bonds. This means that long-rates will be pushed down and short-rates will be pushed up. If gold rises, then Barsky and Summers are right; if gold falls, then Iím right.

At this point Elfenbein is only talking about correlations. But as he continues to discusses his model, he seems to take a causal stance:

I said in my original post that the price of gold is basically a political decision. The Fed can change the game anytime they want to. I canít say whether this will lead to a long-term decline in gold. That will depend on inflation and interest rates. But for now, the gold market is clearly observing the short end of the yield curve.

I don’t want to presume too much about Elfenbein’s belief about any potential causation. But it’s still an interesting question: is there any evidence of causation? If so, in which direction does it run? (more…)

Vitaliy Katsenelson has a good presentation on trouble brewing in China that is worth a quick review.

China – The Mother of All Black Swans – By Vitaliy Katsenelson

One of the data points mentioned is the New South China Mall. Here’s the Wikipedia entry for the mall:

New South China Mall (formerly South China Mall) in Dongguan, China is the largest mall in the world based on gross leasable area, and ranked second in total area to the Dubai Mall. Notably, it has been 99% vacant since its 2005 opening.

Think about that for a second. The mall is 5 years old and has never had more than 1% occupancy!

I do have one problem with Vitaliy’s presentation — misuse of the term Black Swan. Black Swans are rare events that are beyond the realm of normal expectations. While many mainstream economists (or politicians) might not fathom China collapsing, it has happened before and quite a few of us see it as something with a real probability of happening.

Just a quick post, I found this website and it looks like a good source of information on Municipal Bonds, specifically buying individual bonds directly rather than via a fund.

MunicipalBonds.com

Looks like you can search for bonds by state and by type (revenue, callable, etc.). They even have the yield curve for individual states. Seems like a nice resource if you’re interested in investing directly in muni bonds.

Let me get out my crystal ball and make some commodity price predictions about the next two or three weeks…

  • Oil and Copper prices will rise
  • Gold and Cattle Futures will fall

What makes me think that I can predict something like this?

FT Alphaville: Beware, commodity index rebalancing ahead

?The major commodity indices rebalance their respective asset weightings once a year (or occasionally more) – and with that comes a mass dose of buying and selling. The 2009 rebalancing is expected to start sometime this week.

Luckily, JP Morgan has produced its best guess of how the 2009 reweightings of the DJ AIGCI and the S&P GSCI indices will impact the market.

The weightings for both indices are released ahead of time, but begin to kick in the first few working days of the new year. In the case of the DJ-AIGCI – which JP Morgan estimates has $25 billion in funds tracking it – the new weightings come into force during the roll period that begins January 9. The S&P GSCI index weightings kick-in after its January roll which commences January 8. JP Morgan estimates about $50 billion of investment into that index.

JP Morgan see the most significant change coming in the DJ-AIGCI rebalance. Here the market weight of crude oil is expected to increase from 9.6% to 13.8%, gold from 10.8% to 7.9%, copper (COMEX) from 4.5% to 7.3%, live cattle from 6.4% to 4.3% and sugar from 4.7% to 3.0%. Meanwhile, S&P GSCI crude oil weight will go from 32% to 33.8%?.

Don’t be surprised if we see volatility kick up a notch from here…

Here’s a chart from Bloomberg via The Big Picture.

200812231221.jpg

It’s worth noting that with mortgage rates falling, more than a few people have taken the opportunity to (apply to) refinance their mortgage… That should certainly help banks as they are able to make fees on the refinancing, but doesn’t really bode well for sales of actual homes.

Bear markets do interesting things, one of which is to overreact severely on a few stocks. For example, there is a gold mining company that I have followed for a while by the name of New Gold Inc (NGD). Like every other gold stock out there, NGD has been shellacked to very low prices.

Interestingly, if we look at New Gold’s financials, the stock is currently trading with a market cap of $170m (at yesterday’s closing price of $0.80/share). The company currently has $250m in cash, and minimal amounts of debt. NGD is trading at a solid 30% discount to the cash on their balance sheet… so buy buying the shares at $0.80 you get $1.17 in cash, and they throw in several high quality, currently in production gold mines.

Of course, it’s not as clear cut as the previous sentence may make it sound… Rumors have it that New Gold is having some sort of issue with their new big mine, and thus they are not risk free. They’re also spending that cash to continue operations, as companies normally do, so the amount of cash on their balance sheet is not a constant, fixed amount.

Despite the caveats, this is a great bargain for a gold stock right now. And this certainly isn’t the only stock trading at a discount to cash…

Recently I suggested buying of closed-end funds, especially those at a high discount and with high yields.

One of the risks of buying these securities is the fun way the rules and bylaws for the funds take effect. For example, PFL, PIMCO’s Floating Rate Income Fund recently had a press release:

PFL “announced today that the Funds have postponed the payment of the previously declared dividends on the Funds’ common shares…

In accordance with the … Fund’s By-laws, each Fund is not permitted to pay or declare common share dividends unless that Fund’s [assets] have a minimum asset coverage of 200%… Due to current market conditions, the values of the Funds’ portfolio securities have declined, which has caused the Funds’ asset coverage ratios to fall below the 200% Level.”

Oh crap, right? Continuing with the press release:

“…the Funds’ ability to earn sufficient income to pay the previously declared dividends or declare the December dividends was not impacted by this decline in the asset coverage ratios or market conditions.”

The funds have the cash to pay the dividends, but they’re not allowed to do so due to their own rules!

Side note: I agree with this approach, but not everyone does.

And according to an earlier press release, the managers of the fund evaluated selling some of their assets to get back over the 200% ratio…

“To do so would require the Funds to sell a significant number of securities for cash. The Funds do not believe that this is in their best interest at this time. Market conditions continue to be extraordinarily volatile and the Funds believe that market prices do not reflect the fundamental value of securities.”

That’s great if you agree with the managers (I personally do), but sucks if you don’t agree with them, or were counting on the dividend.

Such are the risks of buying funds like this. I think those risks are well compensated for by the high yields and the discounts to NAV… but your mileage may vary.

I’ve thought of something that quite a few people may have overlooked. There is much gnashing of teeth amongst financial conservatives about the Federal Government (thinking about) bailing out GM and Ford.

The part no one seems to realize, is our government is already on the hook for their failures. Not via the lost votes, tax revenue, or general esteem of an American Institution failing… but rather via the bailed out banks.

Something like $1 trillion in CDS paper has been written against GM (CDS = insurance against bond default). It was sold by the likes of AIG, Bear Stearns, etc. It was bought by holders of GM bonds, also known as your pension, the bond funds in your 401k, and probably quite a few others.

So if GM were to fail, the sellers of insurance would have to pay up to make the bond holders whole… and what happens if AIG doesn’t have the money? Well, they’re effectively owned by the US government now, so it’s the taxpayer’s obligation to pay.

I’m starting to think that $50 billion thrown towards Detroit may be cheaper in the long term than settling on the CDS obligations of the partially socialized banks.

Of course, it would be nice to say that the government shouldn’t have bailed out AIG, but that decision has been long since made.

Propping up a zombie corporation like GM or Ford is going to be unhealthy for the economy as a whole… But then again, who really thinks that a $700 billion bailout is going to be healthy for the economy? In theory, we’re stopping a train wreck from getting worse, not preparing ourselves for long-term growth. We’ll keep sacrificing bit by bit to save next year, and pay for it in the next few decades.

I came across a particularly conspiratorial piece of analysis recently that claims that the following 4 statements (used at great length to justify various bailouts) are materially false.

  1. Bank lending to non-financial corporations and individuals has declined sharply.
  2. Interbank lending is essentially nonexistent.
  3. Commercial paper issuance by non-financial corporations has declined sharply and rates have risen to unprecedented levels.
  4. Banks play a large role in channeling funds from savers to borrowers.

We’ve heard all 4 of these statements numerous times… and if I recall correctly, in sworn statements to Congress…

So, what kind of crazies wrote this paper? The Federal Reserve Bank of Minneapolis. Those f**ing nutjobs.

(more…)

As an FYI to market watchers, tomorrow might be an important day because of the Lehman CDS settlement. I expect it to be a catalyst for direction, though I’m not sure which direction that might be.

Basically, CDS (credit default swaps) are insurance against a company’s debt (bonds) in the event that the company goes bankrupt. Since Lehman officially went bankrupt, the insurance companies (pronounced: banks) are going to have to pay the CDS holders to offset their losses in the underlying bonds.

The rumors are that the CDS settlement will likely cause $360 billion in payment. Notice that MER, BX, and MS were all down about 25% today, potentially in anticipation of tomorrow’s settlement. AIG, JPM, BAC, and GS are probably also involved somehow… you may have noticed the headlines about AIG needing an additional $37 billion loan from the Fed… think the timing is coincidence?

Isn’t de-leveraging fun?

Source: Reuters

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