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

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)
http://seekingalpha.com/article/159545-lone-pine-challenges-shorts-with-green-mountain-coffee-stake

* 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"

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".



"...mortgage 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...

...it is all downhill from here...

The author is long SDS at $44.5.

This really scares me

Just one year out from a major financial disaster, some of the most leveraged banks that recently lost billions of shareholder value are now looking to expand their trading operations again. What did we learn from the deleveraging debacle? Nothing.

Apparently even more banks than Goldman Sachs and Morgan Stanley want to get into commodities speculation. Soc Gen and Bank of America hardly seem like the type, but the opportunity to squeeze retail investors out of their nickels may be too great. In case, traders know that the place to make big money is where the volatility is. So I guess if you are down tens of billions of dollars you will be tempted to enter a market a lot of zig and zag.

Aug 31 Update: It looks like Citigroup does not want to be left out and is diving in head first too.

Stimulus Watch: Has China closed the spigot already???

As I have mentioned before, the massive stimulus program in China is driving much of the revival of exports in across the global, particularly in regional partners like Japan and South Korea and commodity producers like Brazil.

But has the Chinese government started to close the spigot of easy money already???

"The benchmark Shanghai Composite Index fell to 3112.72, as data showing a 77% decline in bank lending in July from June raised fears that banks may make fewer loans following record disbursals during the first half. The Shenzhen Composite Index fell 4.4% to 1052.51.

"Even though the Chinese government insists it'll keep a loose monetary policy, the reality may be that some credit tightening measures have already been implemented," said Ben Kwong, chief operating officer at KGI Asia. "The market is worried that a significant slowdown in lending means less liquidity and investors are taking profits."(1)

The evidence of the change might be represented by the recent turn in the Baltic Dry Bulk Index. The index is largely driven by the movement of raw commodities in international trade, and the recent surging demand from China provided a major boost to the index from January's historic lows.



There is still too little data to substantiate a change in the economic climate. But many estimates made by Brazil and even use manufacturers like Alcoa hinge on the sustained growth in China to offset economic stagnation elsewhere. It will be interesting to observe over the next few months if China will be able to maintain it's momentum with or without easy money policies.

(1) "Drop in Bank Lending Spooks Investors; a Fall Back Below 3000?", WSJ, August 14, 2009 by V. Phani Kumar

The whole world is on Viagra

Last night I heard a story about a friend who looks after his 91 year old grandfather. My friend has a dilemma that even though his grandfather's health is failing because his advanced years, he continues to live the lifestyle of someone younger and more spry. In fact on more than one occasion he has found his dear old grandpa passed out in various areas of the house from overdoses of Viagra.

The global economy is experiencing a similar circumstance.

With US port traffic down...

Retail sales down...


imports and exports are down...


There is little sign of virility to the economic situation. Yet the global markets stay excited over the prospects of a turnaround in the face of this information. Why?

Artificial stimulation from bailouts and stimulus plans, of course.

Only $230B of the $787B US stimulus package has been spent to date. But US is far along ($700B) with the housing market stimulus executed with the 1.25T allocation to purchase agency debt. The US is also stimulating the housing market with $500B in purchases of securitized mortgage debt in the open market at exaggerated prices. Without this support, mortgage rates would rise and provide an additional disincentive for the anemic rate of home sales.

There are auto purchasing incentive programs in the US, South Korea, China, and Brazil. The U.S. , the last to adopt an auto purchase incentive program, "Cars for Clunkers" program has been expended from $1B to $3B in funding. The government rebate will be used in an estimated 500,000 car transactions this year in the US. It has been shown before that such stimulus only pulls forward future purchases. Maybe this time will be different...

In the U.K. the government continues to use quantitative easing to support the yield curve and keep mortgage rates down. The U.K. recently extended their quantitive easing program by authorizing another $50B in funds to attempt artificially depress interest rates.

China also is in the process of executing a $586B spending package to maintain economic growth. But this pales in comparison to the loose monetary policy underwritten by the Chinese government. In the first half of 2009, over a $1T in loans has been made, a 1000% increase over the previous year.

The overall stimulus in China has been massive. “They opted for a very quick fix,” said Stephen Roach, an economist and chairman of Morgan Stanley Asia. “Surging investment, fueled by the most rapid bank lending in history, accounted for nearly 90 percent of China’s G.D.P. growth in the first half of this year. And that is worrisome.”

Overall, with Japan, France, Germany, China and soon the US reporting Q3 growth and no top line growth across the whole bunch, it looks like ailing economy is dependent on special pills to stay in the game. Let's hope we don't over exert ourselves in the process.