Monday, September 21, 2009

Stimulus Watch: China stimulus effect declining

Commodities are the key sign for watching the effect of the stimulus program in China. Across the board, signs are starting to show that the largest stimulus program (as a percentage of GDP) is already starting to wane in effect. In the comments, let me know what other factors you are watching to track China's stimulus progress through the system.

(1) Oil consumption

Even though China recently became the #1 consumer of automobiles, oil consumption peaked in July and has been declining. "August seems to have brought a reality check for refiners in China," said Vandana Hari, Asia news director at Platts. "Domestic fuel demand has clearly been lagging their high processing rates, and storage space is finite."

(2) Copper demand

The large state sponsored infrastructure projects drove tremendous demand for copper and semi finished products. There were even reports of pig farmers stockpiling the metal as a speculative investment. But there is cracks in this demand too... "Traders say the market was worried that China, the world'slargest consumer of copper, may have overdone the stock building,which boosted prices in the first half of this year. Chinese copper and semi-fabricated imports fell 20 percent in August from July at just over 325,000 tonnes, and off 30 percent
from a record 476,000 tonnes in June."

(3) Iron Ore

Even iron ore, like copper, linked to China's massive development projects. "Cash prices for iron ore delivered to China from India have fallen 26 percent to $82 a ton since August, according to Metal Bulletin prices for the week ended Sept. 4. Iron ore from Australia has fallen 28 percent since Aug. 13 to $76.1 a ton yesterday, according to the Steel Index. Iron ore inventories at China’s major ports reached 76.5 million tons for the week ended Sept. 4, the highest level this year, according to data provided by Beijing Antaike Information Development Co."

(4) Lending

"The drop in new bank lending -- to an average of 383 billion yuan ($56 billion) in July and August compared with a monthly average of over 1.2 trillion yuan in the first half -- will also pull down transactions in the coming months, said Gao Shanwen, chief economist at Essence Securities."

(5) Constrained Lending -> Real Estate Asset Price Declines by End of Year

Policy tweaks and slower lending will probably be enough for now, analysts say, allowing Beijing to stop short of declaring a full-fledged campaign to stamp out property speculation similar to one in 2007. Ge projected that housing prices would drop toward the end of 2009 or early next year, by about 10 percent, much less than a 20-30 percent fall witnessed last year."

Clearly the world economy would suffer greatly if the program disapated in effect so quickly.

Let me know how you are preparing for the stimulus to wear off and when you expect the timing to occur.

Sunday, September 20, 2009

The TARP game is over, next step is an Uber Big "Bad Bank"

Obama's team came storming into office in the midst of the crisis with all the intent of saving the world financial system. They did it, temporarily at least. As it happened, the crack Obama team handed out cash to failing entities, abandoned accounting scrutiny, and finally provided a little transparency to balance sheets but no accountability for resolution. The markets gained faith in the new system, not because the banks had resolved their problems but because the government was credible and tangible in supporting all major market mechanisms.

This sunlight on the system gave the banks a chance to redeem themselves by opting out of government support by repaying the TARP money. To obtain this freedom, the banks announced their financial health based on increased capital and risk control measures. Was this actually done? No. Now the support programs (agency debt purchases, MBS purchases, T Bond purchases, money market funds(1), home purchase tax credits) are scheduled to lapse. Bloomberg reports "New York Fed President William Dudley, who is vice chairman of the FOMC, has sounded more cautious. "The market expects us to complete these programs,” he said Aug 31. “To contradict that market expectation is a pretty high hurdle.”(2)

What now?

The Obama team remedies addressed the symptoms, but the source was the undercapitalized American consumer and no remedy was found for their plight. As credit cards charge offs, unemployment rates, foreclosure statistics, and many other financial measures all zoom past stress test scenarios, the solvency of the banking system will be in question again by the Spring of 2010. At that point, balance sheets will have to be recapitalized again. Will the banks come back for TARP? No sane bank will risk the public anger of returning to the government as doctor after already claimed to be "cured" and going in for the same penicillin. The credibility of the stress tests will be demolished and the actual health of every bank that took the test will once again be on the table.

What will the government do in that situation? There is no way the Congress will hand out another $750B to the Executive Branch with no strings attached like last time. At least not if they care about holding their jobs come election time. The Executive Branch will have lost their opportunity to single handedly manage the crisis. Instead Congress will take center stage in bringing credibility back to the banking system the only way possible for a government entity. That will require complete nationatization of "bad bank assets" with the taxpayers footing the bill but banks taking a major equity hit in the process.

(1) "Treasury Announces Expiration of Guarantee Program for Money Market Funds" US Treasury Department Press Release, Sept 18, 2009
(2) "Housing Risking Relapse Confronts Bernanke Conundrum"By Kathleen M. Howley, Sept 21, 2009,

The author is long SKF at $25.

Tuesday, September 15, 2009

Stimulus Watch: I hope the Aussies are saving their pennies

Is Australia about to take shot on the chin? Currently the country is navigating the global downturn with exports of raw commodities to China. Is that about to turn?

Australia, which has benefited greatly from China's increased manufacturing consumption of iron ore. China has gone from consuming less than 20% of Australia's iron ore in 2000 to over 80% in 2008. (1) China has even continued to increase their copper imports during the downturn leading to a scenario where their economy exports less but still increases consumption. For Australia, this situations encourages projections based on artificial demand. For China, this indicates uncorrected inefficiencies in their domestic economies that have been papered over by stimulus plan.

There is evidence that the Chinese binge buying has abated...

"In recent months Chinese demand for iron ore -- the primary material in the manufacture of steel -- has dominated freight market activity while also adding to swings on the main index.Port congestion in China as well as off Australia's coast had previously tied up a large number of Capesize vessels, typically hauling 150,000 tonne cargoes such as iron ore and coal. But queues off China have eased.Brokers said reduced iron ore import activity in China in recent weeks was taking its toll." (2)

Considering the torrid pace of the last six months, this could be a breather or utter exhaustion. We will have to wait and look for more evidence before determining how to address the situation.

(1) "Australia finds fortunes ever more tied to China" Reuters, Aug 19, 2009, by Wayne Cole

(2) "Baltic index drifts lower, cargo enquiry light" Reuters, Sept 16, 2009

Monday, September 14, 2009

Stimulus Watch: China went overboard, do the Math

Now that the world economic situation has turned up many are looking for a sustainable environment to allocate investment. Yet is it really a meaningful recovery or just a meaningful temporary stimulus?

The total GDP of China $4.3T USD and the amount dispursed through loose credit policies through the first seven months of this year amounted to over $1T USD. This is equivalent to 25% of GDP lent to domestically to increase consumption.

In comparison the US GDP is close to $14T USD and the stimulus program directly related to the federal budget amounted to $1T USD (Stimulus package + Cars for Clunkers + Chrysler Bailout + GM Bailout + TARP + AIG Bailout). This is a total of only 8% of GDP.

IMHO it is obvious that China has created malinvestment and guided resources into frivilous causes in fear. Considering the size of the error, it will only be a matter of time before this causes problems in their financial system.

Sunday, September 13, 2009

Now is the time for gold

This was originally written 9/13/2009

This blogger is now a gold bug. I tried to fight it, but now it makes too much sense. I even think gold is cheap.

Gold has been used as substitute currency at least since rhe Songhai king Mansa Musa flooded Western Civilization with the metal in the 1500s. In the first part of the 20th century, gold was used to back the government currency. The gold standard was abandoned in US but even today central banks and investors use the metal as a hard currency.

It is often stated that gold is an inflation hedge. It is not just sensitive to inflation. The value of gold rose significantly in real terms during The Great Depression, the most severe modern deflationary period. Gold actually rises in value during times of economic or geopolitical stress.(C) So whether it is the realization of trillions of losses by banks or the debasing of the US currency by massive borrowing by the US government, both scenarios contribute to stress and thus justify an increasing price of gold as a de facto currency.

Evidence of the upside of gold can be observed from many different sources.

(1) Miners

The world's largest gold producer, Barrick Gold, abandoned $3B in prices hedges to get long gold, you have to expect there is upside.(B)

(2) Short sellers

Greenlight Capital is long gold and cites due to emerging market central bank purchases. (D)

The author is long gold at $107.50.

(B) "Barrick Eliminates Hedges, Plans Offer", SF Gate, Sept 8, 2009, by Rob Gillies

(C) "Currency Trading and Intermarket Analysis" by Ashraf Laidi

(D) Greenlight Capital 2009 Q4 Newsletter

Friday, September 4, 2009

Green Mountain Coffee Roasters is piping hot!

The US consumer is currently tightening their belt, losing their jobs, and hunkering down to rebuild their retirement funds. Based on the numbers reported by Green Mountain Coffee Roasters (GMCR), buying a coffee machine seems to be the first step on the road to economic recovery for the American consumer.

As a budding short seller, this stock seemed like a prime candidate to profit from as expectations hit the rocks of reality. At first glance, GMCR holds all the initial signs of a momentum stock out of control. GMCR currently holds a $2.2B market cap and a 47 P/E ratio in a market with declining consumer spending across the board. Yet by the end of the analysis, GMCR looked a momentum stock with a full head of steam with more upside than downside. Here is why....

* GMCR products achieve great customer satisfaction

“During the quarter, we reconfirmed that consumers remained extraordinarily satisfied with the Keurig brewer system. Our quarterly research reconfirmed a top two box satisfaction score that exceeded 92% for all brewer models.”

“Our outlook for fiscal 2010 anticipates a net sales growth rate of 45% to 50%, shipments of system wide K-Cup portion packs to increase in the range of 65% to 70% and fully diluted GAAP EPS to be in the range of $1.70 to $1.80 per share.”(1)

* GMCR has solid organic growth

[Q3 2009]
“It certainly was another outstanding quarter for Green Mountain Coffee Roasters. Net sales totaled $190 million, up 51% over the last year with each business unit contributing strong sales growth. After inter-company elimination, the Keurig business unit net sales were up 97% to $90 million and the Specialty Coffee business unit net sales were up 39% to $100 million. ….
The primary driver of the increase in net sales is the continued growth in K-Cup sales which were up over 79% on a consolidated basis. Sales related to the Tully's brand represented approximately 5.5% of the 61% increase in consolidated net sales and are included in the Specialty Coffee business unit results for the first time.”(1)

* GMCR is rapidly developing new channels for growth and market penetration

“In our third quarter we announced two new licensing initiatives. We licensed Con-Air Corporation to launch a Cuisinart branded Keurig brewed coffee maker during the first half of 2010. We also licensed Jardan to launch a brewer under its Mr. Coffee brand expected during the second half of 2010.

These initiatives are consistent with our fundamental razor blade approach to growing the business which focuses on getting brewers into more households in part by providing consumers with more looks, features, brand choices and price points. Both product lines will be co-branded with Keurig and designed to work with the 200 varieties of gourmet coffee, tea and hot cocoa packaged in Keurig's patented K-Cup portion pack.

With Keurig, Cuisinart, Mr. Coffee all offering Keurig brewed technology, we are seeing to maximize the visibility of Keurig and expand choices for the consumer, thus accelerating the adoption of single cup brewing into homes across North America.”(1)

* GMCR signed deal to sell in Wal-Mart

Wal-Mart is a huge new retail relationship for GMCR to sell the Keurig systems. Although Wal-Mart has a track record of cutting margins on the units it sells, GMCR makes most of their money through the proprietary K-Cup they sell. The Keurig system requires using the K-Cup to function and the owner must keep a supply of cups on hand.

* GMCR has attracted hedge fund interest [Look out for the squeeze, short sellers!]

“In a 13G filed with the SEC, Stephen Mandel's hedge fund Lone Pine Capital has disclosed a brand new position in Green Mountain Coffee Roasters (GMCR). The filing was made due to activity on August 19th, 2009 and Lone Pine now shows an 8.3% ownership stake in the company with 3,603,364 shares.”

Finally, it is very difficult to estimate how much impact all of these new initiatives will have in total. But I am confident that GMCR will have ample opportunity to blow away current sales guidance. That is information that should make any short seller pack up and go home. Or just buy a few shares and go along for the ride.

(1) GMCR, Q3 2009 Results Conf Call Transcript

The author has an order to buy GMCR at $54/share.

FHA is subprime

When it was discovered that Fannie and Freddie were insolvent due to the poor performance of mortgages, Treasury Secretary Paulson, as a condition of guaranteeing the debt, mandated that Freddie and Fannie shrink their portfolios going forward.

The government need another agency to step into the gap and be the guarantor of mortgages so banks would not stop mortgage lending cold turkey. The agency given that charge was FHA and since then the government has become "the market" in mortgages.

"The FHA now insures $560 billion of mortgages—quadruple the amount in 2006. Among the FHA, Ginnie, Fannie and Freddie, nearly nine of every 10 new mortgages in America now carry a federal taxpayer guarantee."

As a house shopper I have been waiting for the strictest lending environment to achieve the best purchasing deal. Yet in the winter of 2007 my mortgage broker approached me at dinner (at the time he was moonlighting as a waiter) and said "Nothing has changed, FHA is the new subprime".

Since 2007 FHA has gone from single digits market share to providing over 25% of the mortgages in the US market. It was thought that the FHA full doc process would prevent the widespread fraud that underminded the ratings on securitized packages of mortgages. Although fraud has declined, I hear from mortgage brokers is still ways to game the FHA mortgage approval system.

Who will pay for the flaws of FHA? You will.

"Federal law says the FHA must maintain, after expected losses, reserves equal to at least 2% of the loans insured by the agency. The ratio last year was around 3%, down from 6.4% in 2007.
If its reserves fall short, the agency is obliged to notify Congress, which could spark a commotion over the extent to which the government is funding losses in the housing market. Some housing analysts have said losses might lead the FHA to pull back lending, which has helped boost flagging housing demand."(1)

This is a big problem. The agency has been the stop gap in the housing market, but now the stop gap is going insolvent. Officials think it could go insolvent by the end of this year.

...Officials said as recently as May that they didn't expect to fall below the 2% limit, but home-price declines have exceeded those used to model their expected losses. Given the pace of those declines, "there is no way they will make the 2%" if the current study follows last year's methodology, says Mr. Lawler."(1)

Although the problems is obvious, the solution is not. Congressional mid term elections are coming up and the Republicans would so much enjoy yelling "spendthrift" at Democrats for making another federal enterprise insolvent in two years. At the end of the day, another back door bailout including a relaxation of capital standards and additional borrowing capacity will probably occur. But the Republicans and Blue Dog Democrats may be able to extract a higher required down payment requirement for FHA loans going forward, or stricter payment to income ratios for borrowers.

The author purchased SDS at $44.5.

(1) Wall Street Journal, Sept 4, 2009, "Loan Losses Spark Concern Over FHA" by Nick Timiraos

(2) "FHA ready to join Fannie and Freddie"

(3) Wall Street Journal, Aug 11, 2009, "The Next Fannie Mae"

Thursday, September 3, 2009

At the top of the hill on the stimulus: What's Next???

This is the peak of the stimulus...

Whatever money that has been made available has been spent...

* The "quantitative easing" performed with $300B of Fed spending will end in October. Will 10y Treasury Rates (which dictate mortgage rates offered by lenders) stay low???

* Over $800B of the $1.25T of mortgage debt to be bought this year has already been purchased to lubricate the housing market. Has housing bottomed???

* 3/4 of the $232 tax cut of the Obama administration has been doled out to the American consumer. Has retail rebounded???

* 1/2 of the $550B in "shovel ready projects" have been paid out

Banks have made their bed...

* Banks are expected to write off another $1T by the end of 2010

* The accounting rule grace period has ended and banks will need to bring $700B of off balance sheet assets on balance sheet

* The banks have paid back the TARP explaining that they are not in need of assistence. Can they go back to the government for another loan if the writedowns are enforced by conscientious auditors? What do you think the regulators will do this time when they come in for money? I think there will be at least one "accelerated wind down" scenario to play out.

* The banks paid back TARP, not because they want more freedom to lend to business in this difficult economic period, but instead because they wanted to freedom to curtail lending and preserve capital during this tough period.

* A non-TARP company loves to see a TARP trapped bank oblige the government and give out loans to the broader market because it means distressed assets to buy at a discount with less hassle later.

* The foreclosure moratoriums have all expired and all the mortgage modification programs have expended tremendous amounts of effort to offer reprieve to the overextended to minimal effect

* A wall of unprocessed foreclosures are mounting and the forecasted peak of homeowners entering the foreclosure process has not even topped out

Obama is facing a challenge to prove his metal...

* What more can Obama do? Better yet, what more can Obama and Congress push through without a revolt? Obama has already moved the public opinion needle from "Fearless change agent" to "Soft on big business". It would be a popularity killer to let opinion turn even further to point to "In Pocket".

" rates are very dependent on the Fed's purchases of $300 billion in Treasury debt that will expire in October and $1.25 trillion in mortgage bond purchases that will expire at year-end. Unless the economy stumbles, we're likely to see higher rates in the fourth quarter."

Government orgs to keep housing afloat are reaching limits

* Fannie and Freddie have a mandate to wind down operations

* FHA has so many deliquent loans that it will not achieve the federally mandated 2% capitalization requirement and thus will require a bailout

In Conclusion...

So what does this mean... is all downhill from here...

The author is long SDS at $44.5.