Tuesday, December 20, 2011

December, Tuesday 20, 2011

DOW +337 = 12,103
SPX +35 = 1241
NAS +80 = 2603
10 YR YLD +.11 = 1.92%
OIL +3.12 = 97.00
GOLD +21.30 = 1616.20
SILV +.76 = 29.66
PLAT +21.00 = 1437.00

Yesterday, Euro finance ministers confirmed they would loan close to $200 billion dollars to the IMF for a fund to help needy Euro countries. It is a less-than-hoped for amount.  The ECB President Mario Draghi said the ECB would not have a Federal Reserve version of Quantitative Easing. So, yesterday was a down day in the markets because the governments weren’t handing out free money.

Spain held a bond auction today and there were buyers. Spain has large debts and large deficits and high unemployment, so it was encouraging to see a good bond auction.  The implication is that Spain can actually pay back their debts. It was only about $7 billion dollars worth of debt, but that was enough to kick start European debt and equity markets, and set an optimistic tone for a scheduled auction of 3-year bonds by the ECB later in the week. Who was really buying? Well there is a good chance that the ECB was propping up the sale – maybe. But it would be wrong to think the ECB and the powers that be are not doing anything.

Today marked the first day for the new ECB bank lending facility, offering unlimited funds to the banks at 1% for up to 3 years. So, a bank can borrow euros from the ECB at 1% and they can buy Spanish bonds that pay 5.1%, they can use those bonds as collateral to leverage more funds from the ECB at 100-to-1 ratios. The program is being called “happy hour for Euro bankers”.

This is not exactly out of the Federal Reserve Playbook, but it is essentially a repeat of the Fed’s “Cash for Trash” program. It doesn’t solve the debt and solvency crisis in Europe but it does address the liquidity crisis by making sure the money keeps moving around, even if it doesn’t move into anything productive. So, the general feeling is that the world won’t end in 2012, or at least it won’t end today.

Meanwhile, German business and consumer confidence rose in December.  This is important because Germany is the big Euro player, and if Germans start to feel pessimistic they might tighten up their purse strings. See, a Greek guy and a Spanish guy and a Irish guy and a Portuguese guy go to an Italian restaurant for dinner. Who pays the bill? A German woman.

Spanish paper fell 11 bps to 5.1 percent.  Italian 10-year government bond yields were about 21 basis points lower at 6.658 percent.  The Treasury market continues to take its main cues from Europe; so, as European bonds rose, US Treasuries fell. This is the craziness of the markets; Greece manages to sell a billion dollars of debt or Spain manages to sell $7 billion and the markets find salvation and valuations rise by tens of billions. Tomorrow, some European technocrat might be feeling intransigent and dogmatic, or some banker may feel he was dissed out of a bonus and the markets will tumble.

At some point it might be nice to get back to a market place influenced by supply and demand rather than corporatist influence peddling.

How do you measure the valuation of a big agribusiness company – by the hundreds of billions they rake in from price supports and subsidies or from the food they produce – and what role is played by their ability to produce food without modifying the genetic structure or polluting the groundwater.

As far as the big banks, well I’ve given up trying to put a valuation on their business. Do we give them credit for being able to write legislation? What if a few senators fall out of their pockets? Do we give bonus points to the CEO for hiding taxable income offshore?

And if we weren’t worried about Europe right now, would we be seeing a recovery in the USSA economy?

Probably not – any nascent signals of economic redemption would surely be foiled by political brinksmanship. If Congress doesn’t pass a bill before the end of the year, the payroll tax for workers is scheduled to return to 6.2 percent from the temporary rate of 4.2 percent for 2011.
In a 229-193 vote today, the House requested formal negotiations on a tax cut extension with the Senate, where Democratic leaders say they won’t discuss a yearlong agreement until the short-term deal is completed.
The real stumbling block is that the payroll tax proposal includes a deal for development of the Keystone XL pipeline project. This is what happens when politicians sell out totally and completely; they can’t do the people’s business because they are too busy doing the business for big oil. Just what is the correct valuation for being able to buy politicians? How much should be factored into the price of a stock? How much do we factor into the price of a gallon of gas?

The simple reality is that the payroll tax cut has been muddled by the keystone pipeline deal – and even though both Republicans and Democrats agree there should be a payroll tax cut – they can’t take their hands out of the pockets of their campaign pimps – and the result is no tax cut. Merry Christmas and a prosperous New Year.

Anyway, the euro rose, not much, but just enough to close above 130. The US Dollar Index was down about a half point but still closed above 80.

Now, there is an old and very imprecise relationship between the dollar and commodities; specifically, we tend to look at the inverse relationship to the dollar and gold. Over the past week, the dollar has rallied and precious metals have dropped. Today, the dollar was down and gold – along with other commodities – moved higher. This is an imperfect trade – if it was perfect, everybody would do it. And so, we’ll keep an eye on these trades. One of the important things is that there has been solid demand for physical gold. As prices dropped, people stepped in and bought the dips and they’ve been taking physical delivery. So, the strange trade is that good news out of Europe is good news for gold. At some point, that dynamic could change – bad headlines could erupt from Europe and push people to the safe haven of the metals.

One of the biggest issues commodity investors have is poor risk management with their investments. The hefty volatility that commodities display can often cause investors to exit a position prematurely, or to hold on for too long. Some may see signs of volatility and simply sell out to avoid further losses when holding on a bit longer would have led to profits. On the flip side, some investors see the volatility as a juicy opportunity and may keep faith in a position that has lost its way. If the underlying fundamentals and technicals change, don’t be afraid to exit the position, but also make sure to not get discouraged by a few rough days.

Oil moved higher. At first glance, it might look like part of a broader rally in commodities; it might seem like a response to positive economic news that promises increased economic activity across the board. But then you have to look at the bigger picture for oil. Part of the price of oil is a risk premium – and the risk is Iran. There is the risk that Iran will get crazy and try to shut down the Strait of Hormuz.  But beyond the most frightful scenario there is a basic explanation – European and American companies are not investing in Iranian oilfields and production is shrinking. Simple supply and demand story.

Now, we also had some good economic news here in the USSA;  shopping malls said sales jumped last week. And the government reported an increase in apartment construction and building permits in November. A little later, we’ll be talking about a report due out tomorrow; the National Association of Realtors is expected to revise their reports of sales of existing homes. The revisions will be for lower sales – possibly 10% to 20% lower sales – since 2007. This is a pretty substantial revision. And it tells us the housing crash was much worse than we imagined, and we all thought it was pretty lousy.

The Federal Reserve said the largest US banks and financial companies should hold extra cash on their balance sheets to cushion themselves against financial crises.
The proposal will affect banks with over $50 billion in assets. There are tougher rules for companies with over $500 billion in assets such as JPMorgan Chase, Goldman Sachs, and Citigroup. The rules call for banks with over $50 billion in assets to hold cash that is worth at least 5 percent of the value of their assets. The cash will cushion them against bad loans and investments.
The larger banks and institutions with over $500 billion in assets will also have to set aside 10 percent of the value of any lending or trading between each other. The Fed is also planning to issue another rule in the future, under which those larger institutions will have to pay a surcharge to their regulators based on the amount of risk in their balance sheets.
The Fed also adopted rules for smaller banks with over $10 billion in assets. These banks will have to undergo stress tests conducted by their regulators to ensure that they are adequately prepared for an economic downturn.
It should not surprise you that the new rules haven’t been implemented yet, and there isn’t a timeline for implementation. It should not surprise you to learn the banks oppose the new rules; they say the requirement to hold extra cash would hamper their ability to make loans also, which would be a much better argument if the banks were actually making loans.

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