Wednesday, February 24, 2010

Oil: Another China play

Some said it was the USD holding up the oil price. Now the USD has retraced to pre-crisis levels vs. other major currencies and the price of oil has not fallen.

As it turns out, China imports are a large catalyst in demand for crude oil.

“China’s growing reliance on seaborne crude oil imports will set the tone of the tanker market for the coming decade,” Poten said in a report to clients, quoted by Bloomberg. “China’s expanding middle class, strategic stockpiling and complex refining capacity ensure that it will continue to be a large ship, crude oil story.”

What is strange is that overall world demand is down, but since China is buying, prices are up. This is somewhat understandable because 50% of the oil futures contracts traded are for speculation. So it is a self feeding machine.

In any case, based on this information I will be looking for an acceptable exit point for my SCO position. I cannot invest with 80% confidence when I see I am fighting the Chinese stimulus investment in oil consumption. I will need to wait to see lending decline prior to taking such a position again.

"China’s crude oil imports may reach an all-time high this year as an economic recovery spurs demand for fuels, data from China National Petroleum Corp. showed on Feb. 4. The Chinese economy, which expanded at the fastest pace in the fourth quarter since 2007, will grow four times faster than the U.S. in 2010, the United Nations said in December.

Chinese charterers accounted for about 30 percent of VLCC spot fixture activity this year, up from below 5 percent a decade earlier, Poten said."

Turkcell on sale

Simple market thesis, find a wide moat, buy and hold. Easier said than done.

Turkcell, the #1 cell phone provider in Turkey is one such company. Beyond the huge domestic market share (57%) and wonderful dividend policy (50% of profits to shareholders), this company holds a huge economic moat. The mobile telecom market naturally requires huge capital investment, and thus the barriers to entry are huge. Also, as in most emerging economies, telecom companies are often partially privatized but still national champions of the current regime. Turkcell is no different. No one in Turkey wants Turkcell to fail.

Purchasing this stock with .79 cent dividend (5.1% yield at $15) does incur currency risk. But economy of Turkey has held up very well in the recent economic crisis and has even been marked for a rating upgrade by the major rating agencies.

Although a large part of Turkcell is already foreign owned, at some point in the future I could see a major multinational moving in and buying Turkcell to extend their geographical footprint. But for now, I am content with the high growth and high yield.

The author is long TKC at $15/share.

Tuesday, February 23, 2010

What Euro crisis? I smell opportunity. Buy Euro debt

Headline: Fiscal deficits across Europe threaten to blow apart the Euro.

So what? Who cares.

Let's think about this. Germany is right now benefiting from low budget deficits and artificially lower currency base because they belong the Euro. Exports are recovering because Germany is one of the most competitive exporters of the European Union.

Let's look down the road... worst case, one of the PIIGS default. The euro is abandoned by the European countries and the deutsche mark (DM) is reinstated. The DM soars and exports suffer. Another recession ensues. Painful, not a killer.

More likely...the PIIGS are dragged along without "technically" defaulting. A bailout, backdoor or front door, will just continue to dilute the euro trying to regain competitiveness. The German banks will take some writedowns and move on. Is this bad? Bad for Europeans trying to retire. But not bad for the survivor PIIGS who need to export their way out of their recession.

With this said, what could be on sale during this storm?

Long Credit Suisse Subordinate Debt Notes yielding 7.90% at par ($25 Par), buy at $17/share (NYSE:CRP).

Long Deutsche Bank Subordinated Debt Notes yielding 6.35% at par ($25), buy at $13.5/share (NYSE:DUA).

Wednesday, February 17, 2010

US Deficit Management: Feeling in the dark

If there is anything that keeps stomach of the average US investor in a knot, it is the size of the US deficit. For all the story of US growth prospects, with the deficit always looming in the background, there is a feeling that whole system could fall to piece if this issue is neglected. The US deficit is huge. At this time of economic stress, it is important to ask if US at immediate risk? If not, what are some scenarios which could be a tipping point?

Right now, the US is not considered to be a major risk. The US has no problems rolling over their debt at any maturity. We don't know how long that will be so easy. Yet there are other countries with more immediate debt concerns that may be a canary in the coal mine.

Yet as the Economist notes above, the US one of the lowest average duration measures of all heavily indebted countries.

As a course of the recent stimulus financing, the US has been selling heavily into the middle of the medium term of the yield curve. This helps by lowering debt payments on debt rolled over. In fact, the US has actually reduced their interest payments in 2009 recently because of our focus on issuing debt in the 3yr to 7yr range of the yield curve.

Essentially is a leveraged bet on the future economic growth and fiscal management. If there is an econmic shock or significant inflation causing higher interest rates in a 2.5 to 6.5 year period, the rollover of the remaining debt will cause a marked increase in debt servicing payments. This is particularly of concern because the overall US debt schedule will be so focused on the front end of the yield curve causing a massive rollover of debt in just a few years.

Who knows if we will be ready, or just in worse shape from kicking the can down the road, when that time comes?

Scenarios that could cause US debt to become a noose....

1. China decreases consumption of US debt

If China reduces stimulus too fast it's accumulate such massive amounts of foreign currency and becomes a long term net seller of US debt instruments

2. Japan decreases consumption of US debt

If Japan faces a large deflationary spiral or exports do not recover, it must decrease purchases to amortize it's own debt

3. Oil producers decrease consumption of US debt

If a world wide economic slump causes the price of oil to drop, some major oil producers (Middle East, Russia) who also are responsible for purchasing 10% of US Treasury debt, decrease purchases and unload their holdings

Deficit hawks, doves, and peacocks can crow all they want about deficit reduction or increased deficit spending. The looming threat of a debt crisis will remain until there is a cultural transformation regarding fiscal management to reduce short term borrowing needs.

Tuesday, February 16, 2010

USD bull momentum continues

Many doubted the USD. Called it dead and buried.

The USD has started to prove a better choice amongst world currencies. Analysts observing the change in the situation have revised estimates of the 2010 value of the USD vs Euro to reflect the trend toward USD strength.

In fact, large amounts of money has also started to point toward continued USD strength.

"According to data compiled by Scotia Capital, traders were net short the euro—meaning on balance they were betting it would decline—by a record $9.9 billion last Tuesday.

That is a 31% increase from the previous record set a week before. Traders were net long U.S. dollars by $7.9 billion, on a par with levels last seen during the financial crisis."

Once again, there are huge deflationary forces taking hold this year....

1. HAMP ends, massive short sales to ensue
2. Agency mortgage purchases by the Fed end (at least for a little while, may restart later)
3. QE using treasury purchases end (again, probably temporary - six months at most)
4. World wide stimulus programs end (South Korea, Brazil, Australia, India, etc)
5. No cash for clunkers
6. Declining influence of the US fiscal stimulus

... and many more

Plus the "flight to the USD" effect from...

1. Euro zone debt crisis
2. Dubai "restructuring" (default at 60 cents on the dollar)
3. Would you put your money in China an export economy with stimulus at 20% of GDP???
4. Massive Japanese QE (Not here yet, but definitely coming by May, no doubt)

Even though the US has huge debt problems, compared to other countries, their issues look reasonable. The Economist ranks the US and UK after the PIIGS for sovereign debt risk.

The flaw the US is the relative short maturity date of the debt. But one crisis at at time. For now, there is no problem rolling over US treasuries in short maturities and thus the USD IMHO is still on a long bull run.

Monday, February 15, 2010

As much as I would like to do it again...

... it seems the rules of the game have changed.

Back when the world was simple and the banks were audacious enough to mark-to-market, a novice speculator like myself could use news of credit events to short banks before the losses were annouced. But even credit agency reps admit, this is no more...

"The recent credit crisis was over a few trillion in bad, mostly US, mortgage debts, with most of that at US banks. Greek debt is $350 billion, with about $270 billion of that spread among just three European countries and their banks. Make no mistake, a Greek default is another potential credit crisis in the making. As noted above, it is not just the writedown of Greek debt; it is the mark-to-market of other sovereign debt.

That would bankrupt the bulk of the European banking system, which is why it is unlikely to be allowed to happen. Just as the Fed (under Volker!) allowed US banks to mark up Latin American debt that had defaulted to its original loan value (and only slowly did they write it down; it took many years), I think the same thing will happen in Europe. Or the ECB will provide liquidity. Or there may be any of several other measures to keep things moving along. But real mark-to-market? Unlikely. "

So although the Greece bailout, Dubai default, and PIIGS bond auction failures all point to bank losses, a speculator will need to be very careful determining the course of action to protect their financial position.

Friday, February 12, 2010

Short Oil: USD strength will drive oil down

Over the past six months, the leveraged rise of oil prices has been largely been explained by the drop in the USD despite over two years of continuous slide in demand for oil.

Yet over the last two months the USD has started to shoot up and oil has mildly corrected in kind.

... despite reports of excessive inventory. In fact, some traders are still optimistic regarding oil in the face of these bearish indicators.

Marketwatch reports ...

"The Greek bailout is helping support global markets and the price of oil," [Mike Sander, investment adviser at Sander Capital in Seattle] said. "If Greece was leaning further along to a default, then we would have seen oil break $70 for sure."

The inverse relationship between crude prices and the U.S. dollar has decoupled over the past three sessions, which may continue if the stock market stays strong, said Jim Ritterbusch, president of Ritterbusch & Associates, in a note to investors.

A large build in U.S. oil stockpiles may also be overshadowed by developments regarding the European Union's plan to address Greece's debt issues, he said. "We expect wide price swings in both directions going forward as an unusual crosscurrent of financial guidance will occasionally be butting heads with bearish underlying oil fundamentals."

To think that data from three trading sessions identifies the decoupling of a year long trend is a little far fetched.

But as far as the Greece debt bomb destroying the price of oil, I highly doubt Greece will default either. It is not in the interest of anyone with real money that they do default. But as soon as Greece gets their bailout package, the other PIIGS will come to the trough. The question is not if one can be bailed out, but will all of the countries with debt solvency issues be bailed out. This fear will be enough to drive the market to the USD and put longer term pressure on oil.

Even without a crisis in the making, forecasts for oil consumption are not strong. Whether it is demand fundamentals or technical factors, both provide tremendous demand for the USD that makes the price of oil in USD look very expensive.

This disconnect cannot stand. Oil will correct in correspondence with the new demand for the USD.

The author is short oil by going long SCO April $16 calls purchased at $1.40.

[Oil demand chart in the US]

Tuesday, February 9, 2010

Roubini right in long run.... but in the long run...

... were all dead.

Roubini's recent comments that "The USD will devalue by 15% - 20% over the next few years" makes sense, assuming China keeps it's stimulus in place and consequently emerging market commodity providers continue to grow. But in the more visible and short run, the USD looks much more fierce than that long term assessment.

The Greek drama is just the prelude to a string of sovereign financing crisises. The risk premiums will return and the spreads will widen as countries compete with each other for funds to borrow. During these bond auction charades, the US will look safe and secure. Remember, the treasury issued the most debt between the 3yr and 7yr maturities, so the bulk of US massive stimulus funding does not start to come due for a couple more years. Moreover with the unwind of programs for QE using treasuries, mortgage backed securities, asset backed securities, bank debt guarantees, foreclosure moratoriums and whatever else by this March, deflationary forces will come back in force in the US.

So although monetary stimulus has set the stage for inflation when price support is found, the immediate drama in the Eurozone guarantees that the USD will stay strong for a while. In this market, a while is a mighty long time.

Sunday, February 7, 2010

Greek drama

The dramatic events playing out in the press regarding Greek sovereign debt are almost guaranteed to manufacture a happy ending to the final act. But the real outcome will be when the curtains are closed.

It was just a matter of time before all of the global bailouts led sovereign nations to severe debt strains. Unlike the subprime crisis where there was disclosure and mark-to-market accounting for a little while, national fiscal conditions of the PIIGS (Portugal Ireland Italy Greece Spain) are ripe for off balance sheet manipulation. Look at how the US keeps Freddie and Fannie off the official debt tally even though they are now explicitly supported by the US taxpayer.

Moreover, when Iceland's banks were on the brink, the IMF swooped in and recapitalized the country. Who funds the IMF and influences their largesse? The same central bankers (US, Japan, UK, Germany, China) whose banking interests would suffer from any economic shock wave or market turmoil.

"Privately, American officials have said there is next to no chance that Greece will default on its debts. They said European officials were balancing a conviction that the International Monetary Fund should not be involved in solving Greece’s problems with their belief that political pressure was necessary for the Greek political leadership to cut spending and raise revenues."(1)

Greek change of heart? Not even an interesting subplot, Krugman noted that Greece has spent 50 of the last 200 years in default.

But since the issue of sovereign debtors needing forebearence will be a common theme this year, there is lots of interests in not seeming too lenient in the public. Otherwise everyone will want the same sweet deal. Another resolution will be a backdoor bailout by a willing party with an off balance sheet swap deal with funny accounting. If I were to write the script of the conclusion to the third act, it would be "You pay me $100B USD now and I pay you two payments of $75B USD of Yen over the next two years and your government buys only Toyotas for the next ten years." This has been done before.(2)

No matter what monologue of despair or dialogue of conflict plays out in the press, the final act will be a private arrangement where the main actors are major investment banks and quasi government investment vehicles. In fact, Goldman Sachs is at the tip of the spear making sure the conclusion of this drama is a happy one, at least in public. (3)

(1) "Group of 7 Vows to Keep Cash Flowing" New York Times, Feb 6, 2009, by Sewell Chan
(2) "Traders, Guns, and Money", written by Satyajit Das, p. 106-10
(3) "Is Greece’s Debt Trashing the Euro?" New York Times, Feb 6, 2009, by Landon Thomas Jr.

Feb 14, 2009 update

This article confirms my speculation was spot on.

"In Greece, the financial wizardry went even further. In what amounted to a garage sale on a national scale, Greek officials essentially mortgaged the country’s airports and highways to raise much-needed money.
Aeolos, a legal entity created in 2001, helped Greece reduce the debt on its balance sheet that year. As part of the deal, Greece got cash upfront in return for pledging future landing fees at the country’s airports. A similar deal in 2000 called Ariadne devoured the revenue that the government collected from its national lottery. Greece, however, classified those transactions as sales, not loans, despite doubts by many critics."

After this initial deception to get into the euro... there was even more deception to stay in the euro...

"The answer was no. But in 2002, accounting disclosure was required for many entities like Aeolos and Ariadne that did not appear on nations’ balance sheets, prompting governments to restate such deals as loans rather than sales.
Still, as recently as 2008, Eurostat, the European Union’s statistics agency, reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.”
While such accounting gimmicks may be beneficial in the short run, over time they can prove disastrous.
George Alogoskoufis, who became Greece’s finance minister in a political party shift after the Goldman deal, criticized the transaction in the Parliament in 2005. The deal, Mr. Alogoskoufis argued, would saddle the government with big payments to Goldman until 2019.
Mr. Alogoskoufis, who stepped down a year ago, said in an e-mail message last week that Goldman later agreed to reconfigure the deal “to restore its good will with the republic.” He said the new design was better for Greece than the old one.
In 2005, Goldman sold the interest rate swap to the National Bank of Greece, the country’s largest bank, according to two people briefed on the transaction.
In 2008, Goldman helped the bank put the swap into a legal entity called Titlos. But the bank retained the bonds that Titlos issued, according to Dealogic, a financial research firm, for use as collateral to borrow even more from the European Central Bank.
Edward Manchester, a senior vice president at the Moody’s credit rating agency, said the deal would ultimately be a money-loser for Greece because of its long-term payment obligations.
Referring to the Titlos swap with the government of Greece, he said: “This swap is always going to be unprofitable for the Greek government.”"