To My Good Blog Buddy, Nirav

(Note: Nirav's post tried to make the case that Deflation is just a mirage made up by government flunkees to fool us into believing massive printing of dollars is needed. This would lead to Hyperinflation that would sink our economy. Instead, Nirav wants to see big tax cuts and dramatically lower government spending, along with increased consumer saving and decreased spending. He comes from the Jim Rogers school of economics). http://livingoffdividends.com/2008/12/18/the-deflation-scam/#comment-26971

Nirav, I had a hard time understanding the point of this post Nirav, I had a hard time understanding the point of this post.

The title declares that Deflation is a Scam. This implies it is something made up or false, maybe a government conspiracy. But nothing in the post makes the case for any of that. Your data from the Government show that we have experienced a -12.9% contraction on “All Items” through November. That is the definition of deflation. Are you saying those numbers are made up or falsified? The same data show that in some areas, like Education, there has been some small inflation. But overall, we are experiencing a currency deflation.

It would really be quite hard for you to convince me or probably most others, anything else. We can see it all around us, whether it is gas prices, home prices (and eventually rent as vacant homes create competition for apartments), utilities; even food will come down since raw ingredients like grain have dropped a lot in six months.

There is no question that we are experiencing deflation right now, today. The only question that can be debated is really more a speculation: will we experience deflation tomorrow? I commented in my last post that the government is TRYING to create inflation. It is working very hard to push people away from cash. By definition, that is the only way out of deflation. Any increase in price, even just to get us back to zero price change, would be defined as inflation (or maybe “dis-deflation”?)

Because inflation is the only way out of this mess, it is better to just plan for it (invest in the correct stocks and commodities, and probably not bonds), rather than make arguments that we shouldn’t have inflation. Almost all economists agree that some amount of inflation is required in a healthy economy. Inflation means growth. It means there is demand for the economy’s goods and services. It is excessive inflation that is a problem (over 5% maybe?) not inflation itself. Deflation ALWAYS means a sick economy. It is never desirable for declining aggregate prices since it means too little demand for the amount of goods and services the economy can produce at optimum production.

And what does any of this have to do with tax policy? A deflation is not a tax event nor is an inflation. “The head of the International Monetary Fund, Dominique Strauss-Kahn, warned that advanced nations will be hit by violent civil unrest if the elite continue to restructure the economy around their own interests while looting the taxpayer.” Huh??? That statement by someone name Strauss-Kahn(S-K for short? I don’t have much regard for economists with the IMF) makes little sense. Is S-K a Republican or conservative? What does he/she mean by “restructure the economy around their own interests while looting the taxpayer”? That is non-sensical.

The assertion by some that a Republican controlled government would “restructure the economy for their own interests”, though I would not agree with the notion, is at least logical. Republican’s generally favor “supply side” economics that reward the captains of industry (high tax bracket) with the hopes of “trickle down” benefits to the proletariat workers. I understand how this could be perceived as “looting the taxpayer” in the way of S-K’s thinking.
But the new Democratic Administration and Congress, which support and are driving our current economic strategy, are trying to reflate and support the massive financial restructuring TO BENEFIT the proletariate, NOT the elite. The Dems are for socialism, if anything. Obama himself said he wants to redistribute wealth from the rich to the poor. So, current policy favors the poor. Seems hard to get to Civil Unrest from here.

Now a good deflation, that is how we get civil unrest. High unemployment goes with deflation, almost by definition: as prices fall because of declining demand, business cuts back its production to decrease supply; to cut back production it lays off workers; fewer paid workers creates lower demand leading to even lower prices; and so on. Once there is 15% or more unemployment with many literally out in the streets with nothing to do: well you know the saying about idle hands. Check out the civil unrest in France the past few years for a reference.

So, stop worrying so much about inflation. It is the least of our worries right now. To get to hyperinflation requires the destruction of a country’s productive assets, ala Germany after WW1. Then, any printing of money is hollow, since it can’t be exchanged for anything tangible (like the dollar can be for desirable American assets like Pebble Beach). As long as money is exchanged for assets, even if impaired, it is not devalued by the action. This is why TARP is not really “printing money” as many proclaim. Something was received in kind for the capital infusions, namely assets, either ownership for taxpayers in the company (80% in a a couple cases) or in securities held, like RMBS’s or CDO’s (which contrary to popular opinion, do have some value).

It is much easier to pick good investments during inflation than right now during a deflation. Do you know even one good asset class right now? The answer is no, unless you cite the horrible US dollar (that no one wants, until right now, when it is all anyone wants). I welcome inflation. 5%, no problem, in fact GREAT; 10%, I can still find lots of ways to make money; 20%, okay, there is a limit, but we saw in 1980 how we get out of that one.

A Turning Point in the Bond Markets

"It is always darkest just before the dawn." This very old and somewhat trite saying, is nevertheless very true (unless the moon happens to be high in the sky at 4am). It goes for our financial markets and the economy as well. We are in the deepest economic decline since the Great Depression. And if not for quick action by our Federal government, we might even exceed the depths of "The Greatest". Whether you agree or disagree with the philosophy of a central bank that interposes itself into market workings, it is hard to deny it is having some effect.

Yesterday, Ben Bernanke shocked the world by dropping the overnight Fed Funds rate (rate at which banks can borrow very short term from the Fed) to 0-0.25%. Basically, free money. In one way, this is just recognition that is where the short term Treasury rates are anyway. No point in keeping the overnite rate at 1.0% when the 3 month and 6 month Treasury bonds are yielding 0.01% and 0.2% respectively as of today. For these rates to be good investments, the currency MUST deflate (each dollar be worth more at a later date). But more likely, the buyer of such Treasuries just is making sure he still has tomorrow what he has today.

The past few weeks have also put to bed any notion that Gold is the world's safe haven currency. There has never been a time, probably not even the 1930s, when such a currency has been more in demand than right now. Yet, what do the world's investors flee to in times of absolute financial terror? Gold?.... No way....US Treasuries, instead. The irony is that the more money the Feds print, the more expensive it gets as measured by higher priced / lower yield US Treasury bonds. What a deal the Feds have (and by extension, we taxpayers). This anomaly is allowing the Fed and Treasury to buy up all the toxic mortgage and corporate debt at almost no cost to the taxpayer, at least not yet!

What this all suggests is that we are at another bottom of sorts, a yield bottom. Or to take the inverse, we are at a Treasury bond market top. Tops and bottoms when they can be identified, always make for a good time to evaluate a position and make changes to it. There are two possible routes in the bond world that make excellent sense at this time. One, go short the Treasury bonds by selling short Treasury ETFs, like (IEF), or by buying Ultrashort Treasury ETFs like (PST).

Another really good strategy at a yield bottom like now, is to go to the other end of the credit quality spectrum and buy the hated high yield (junk) bonds that now at historic spreads (differentials) to Treasuries. Even James Grant, a super-contrarian who called the credit and market crash years before it happened, likes high yield corporates and senior bank notes at this stage (see below). Today's high yield bonds are at a 20% spread over Treasuries (which is to say they are yielding right about 20% with Treasuries near zero). The normal spread of high yield corporates over Treasuries is around 6-7%, and the spread was as low as 4% in 2006. There will eventually be a reversion to the mean. Moving from 20% spread to 7% spread should result in at least a double for the high yield market. In the meantime, reinvest the 20% annual dividends to buy more fund shares.

I am counting on the Fed fiscal and monetary actions to turn around the economy, forestalling any wide spread defaults on corporate debt. I personally have loaded up on junk funds. I am buying into the Fidelity Advisor High Income fund (SPHIX). Another good mutual fund I have owned in the past (in 2002-03 before the recovery in that cycle) is Vanguard's High Yield, (VWEHX). A new low cost IShares ETF is also available under the ticker (HYG). I have done a comparison and all three trade in lockstep and have a similar yield around 12% as of today (a little lower than the junk bond universe because the quality is somewhat better in these funds). So, pick your favorite fund company and go with it.

Here is what James Grant said yesterday about a similar class of investments, senior bank loans, which have been heavily sold as a result of the hedge fund unwind. Senior bank loans were part of the "carry trade" play, with hedge funds borrowing short term, low interest loans like Japanese bonds, and then buying higher yielding funds like the senior bank loans. As hedge funds were forced to meet redemptions the past six months, Seniors and High Yields, were sold off indiscriminately:

Grant Says Forced Sales Create Opportunities in Bonds

By Carol Massar and Gabrielle Coppola
Dec. 17 (Bloomberg) --

Investors seeking safety in Treasuries may be missing out on opportunities created by forced selling in credit markets, according to James Grant, editor of Grant’s Interest Rate Observer.
Investment-grade corporate bonds are paying record yields relative to benchmark rates, “in this time of zero yield elsewhere,” Grant said today in a Bloomberg Television interview. Residential mortgage-backed securities and bank loans secured by assets are also attractive now because money managers forced to dump the securities to meet investor redemptions have made them artificially cheap, he said.

Yields on investment-grade bonds relative to benchmark rates have hovered near record highs as investors shun all but the safest debt in the deepest economic crisis since the Great Depression. The Federal Reserve cut its benchmark interest rate to as little as zero yesterday, further reducing yields on Treasuries, to try to ease the yearlong recession.

“Of course there’s trouble, that’s why there’s a bear market,” Grant said. “But that’s when you’re supposed to be interested in value. It’s not when everyone’s happy.”

The average yield over benchmark rates on investment-grade corporate bonds was 651 basis points yesterday, 5 basis points shy of the record high set Dec. 5, according to Merrill Lynch & Co.’s U.S. Corporate Master index. A basis point is 0.01 percentage point.

Market ‘Anomalies’

Forced selling may be distorting prices for secured bank loans. Senior bank loans that are higher up in the capital structure of a bank, meaning owners of the bonds would be paid before other debtors in the event of a default, are trading at lower levels than junior portions of the structure, he said. That means safer loans are cheaper than their riskier counterparts.

“All these anomalies are part and parcel of the liquidation in the credit market,” Grant said.

“That’s why we’re bullish on credit, because so many things simply don’t add up.”

Grant is the founder of Grant’s Interest Rate Observer, a financial journal. He was a columnist for Barron’s before founding the Observer in 1983.

Comparisons between 1930 and 2008

It is very clear we are in an historic economic period. As I have said (maybe too many times?) before, "History Repeats (or at least it rhymes)". But which period are we comparable to? The 1930s or the 1970s? This is the big question because the proper investment (and survival) strategy are almost opposite.

The 1930s was a period of terrible deflation leading to economic Depression. There are a lot of parallels between then and now. Are we headed back to the 1930s, or worse? Some would have us think so, in which case sell everything and go 100% to cash and hide it under the mattress.

On the other hand, this period could be more like the 1970s. Again, there are many reasons to think so. And the strategy in this case would be to buy everything possible that is a real asset. Paper money (cash) just becomes more worthless every day with inflation and a stagnant economy. Real assets will grow in value at least as fast as inflation reduces the value of a dollar.

I won't try to answer the question because there is not enough information to know for sure (and if I really knew this answer, I could name my price). But I did find some interesting academic notes on the subject from an Eric Rauchway, an economics professor at UC Davis and author of a noted book on the Great Depression. You can read his notes or hear his podcast at this web link:

http://www.econtalk.org/archives/2008/12/rauchway_on_the.html

If you don't want to take the time to listen or read in entirety, here are a few bullets that compare the 1930s to now, paraphrasing the author / interviewee, Rauchway:

• Fed raised interest rates, first in 1928 to attract foreign investment; Followed by drop in consumer spending. Immediate transfer via the uncertainty mechanism to the real economy.
• Parallel, recent drop in automobile purchases after Fed raised rates in 2006 to cool economy;

• 1930: people afraid they will lose their jobs;
• 2008: Bankers afraid they will lose their jobs and be unable to pay their bank borrowings back. Strange that Treasury Secretary Henry Paulson is angry about that, given the history. Nice parallel with the 1930s.

• Hoover administration created the Reconstruction Finance Corporation in 1932,
• Similar to the Troubled Assets Relief Program (TARP) in 2008.

• RFC originally going to lend money to banks to prop them up. Realized that this is not going to work and they have to recapitalize the banks. Hoover doesn't like the idea of buying bank stocks (nationalizing) in return for the capital (big mistake, as it helps bring public support on board and eliminates moral hazard).
• We recently went through in a few weeks what we went through from January 1932 to March 1933 back then. We sped it up, and we accepted bank equity or warrants in exchange for capital. However, the speed discomfits consumers. Banks now are rather cautious in lending, as a result of speed and uncertainty. Consumers are not yet spending.

• In the 1930s, Fed administrators were frustrated that the banks weren't lending after being recapitalized; RFC said it would lend in their stead, only to find that there weren't enough qualified borrowers.
• Maybe we'll recover much quicker too (because the bank recap was sped up). Uncertainty about what may happen next is offsetting, (though and is holding back lending). Lending encouragement is working as shown by declining spreads between various lending classes like mortgage rates and Treasuries. We must avoid being too conservative in our qualification of borrowers and must make borrowing very attractive with excellent rates and terms;

But here are ways the two periods are quite different, to the benefit of the current period:

• Hoover signed the Smoot-Hawley Tariff Act, with some zeal. Contrary to the myth that he was a laissez faire ideologue. Not a stand-idly-by guy.
• So far we have avoided any protectionist legislation, like rescinding NAFTA. Protectionism shuts off a need source of capital flow.

• Hoover became increasingly desperate through 1932. At some point you have to say Hoover should have been doing more. Hoover tried to coordinate businessmen to prevent a drop in wages. Ineffective, can't get enough businessmen to agree.
• We now know that direct government control of the economy does not work. Nixon proved again in 1972 with wage-price freeze. Get around it by letting companies laying people off--pay higher wages but hire fewer people. This keeps consumers buying, if fewer consumers;

• In early 1930s, unemployment was about 25%, annual figures: just shy of that in 1932, about that in 1933.
• From that experience we know now that unemployment is necessary, so wages will fall to a point to entice firms to hire workers; but if people don't have jobs, economy won't recover, people don't have any money to buy things, so firms have no money to pay for more employees. Circular flow of macroeconomics understood and hard to navigate politically.

• Difference then vs. now: no unemployment insurance, no deposit insurance, no old age pensions--state level and some private stuff, but tapped out by 1931 or 1932. Agricultural difficulties of the 1920s also used up some of these social welfare resources (in farm states).
• Now there is an extensive social welfare safety net at the state and national level; Feds can create money if needed, to keep people fed and sheltered; can also provide funding to states if needed and can provide medical care and food stamps, programs not in place in early 30s.

• In 1930s as people lost jobs, they drew money out of their savings, putting pressure on the banks. Banks already suffering because foreign debt was going into default (post WW1); stock related debts (margin accounts) going into default; municipalities and states going into default. No brake, no way of softening the blow.
• Today we have FDIC deposit insurance, hence eliminates runs on banks. Banking system won't collapse.

• In 1930s, there is a stark contrast between Hoover in 1930 and Roosevelt in 1933 (with hindsight). Hoover doesn't do anything to stop the bank runs. People's savings just vanish, no recourse. Lack of confidence in the system with no deposit insurance, people wondering if their bank will be next.
• We have many protections in place today to avoid bank runs as witnessed recently, especially Indymac

An even earlier depression in 1894, was the worst depression before the Great Depression. It was 40 years before the 1930s Depression (notice the 40 year cycle?) and somewhat fresh in people's minds, pretty horrible, but we don't have good measures. What happened to banks in 1894? There were pressures on banks.

There is controversy over how bad the unemployment was and how contraction of the money supply contributed to the 1894 Depression. But in 1930s, the money supply contraction can't be laid at Hoover's feet--the Federal Reserve was at fault for that. They created money on one hand to recapitalize failing banks, but took it away with the other, believing if they didn't it would create uncontrolled inflation (which we now know is better than uncontrolled deflation and is the stated goal of Bernanke and probably L Summers to come).

Hoover did increase spending, limited by institutions of the day (or lack thereof) and circumstances. But the Federal government wasn't big enough in the early 1930s to have a big effect on the total economy. Hoover tried to create big increases of public works by working with the state governments. But too little, too late, not enough stimulus."

These are the conclusions, in short, of Eric Rauchway. They are even better understood by Ben Bernanke and also by new, incoming Chair of the Council of Economic Advisers, Christina Romer. She is said to be more an authority on the Great Depression than Bernanke.

Logically, the best way out of excess debt is inflation. Inflation allows the debt to be paid in ever cheaper dollars, at the expense of the lendor, of course. But that is a story for a later day. So, if Bernanke and Romer have learned from the 1930s and do everything that it is said Hoover, and then FDR did not do, namely not doing enough to stimulate the economy, I think it is a solid bet they will ere on the side of over-stimulation which will lead to inflation and a run in hard asset prices.

Tough Sledding in the Markets and Economy

The jobs report came out this AM and it is not good, even very bad news. Job cuts of 533K were announced for November and October was revised up (down) to 320K from 240K; September was revised up to 403K from 284K. That is a lot of job loss the past 3 months, the worst since Q2 of 1980 when Paul Volcker shocked the economy into submission with 20% interest rates.

But those of us who follow the market daily are not too surprised by this bad employment "print". The stock market has been crashing anticipating very bad economic news, serving its function as oracle of the economy. And some of us (me) have seen job cuts at our own place of employment based on painful forecasts for 2009. So there is a very good chance the lousy numbers are already "baked in the cake" of the stock market. Today's (Friday's) early stock market action certainly suggests that, as the DJI is only off by 90 as I write now, but still well above the lows from mid November.

All of the economic slowness, global recession and the resultant strength of the dollar is just hammering energy, much to the displeasure of my portfolio. But at the same time, the government policy makers around the world appear prepared to "throw the kitchen sink" at the economy to get it going again. This will mean a recovery in 2009, maybe beginning as early as Q2. As soon as the world economies recover, the demand for energy will return and drive oil prices back up, though maybe not to $150 since the hedge funds have been hit hard and leveraged speculation in the near future is unlikely. But I think we could all live with $75-80 oil which more accurately reflected the rising demand and tight supply of early 2007. Prices in that range are economically sustainable and would create a stable environment for the Canroys.

I am swallowing hard and holding on to my energy shares, knowing that there will someday be an economic recovery and when it comes, there will also be some inflation to pay for all the money pumped into the economy. Higher economic demand accompanied by mild inflation will be a good environment for commodities and energy.

Here is more on oil:


$25 Oil Could Happen Before a Return to $100
December 05, 2008
By Matthew Hougan

http://seekingalpha.com/article/109393-25-oil-could-happen-before-a-return-to-100?source=article_lb_articles


Jim Wiandt says that oil will go to $100/barrel before it hits $25/barrel. I'm not so sure.

The reason I'm confident that the Dow Jones industrial average will top 10,000 before it hits 6,000 is that stocks are a leading indicator. They anticipate recoveries, typically turning upward 6-9 months before the economy as a whole. We are already one year into the recession, so I'm guessing we are getting close to the point where stocks will turn the corner. When you add in the fact that valuations and yields are the most attractive I've seen in my adult investing life, the outlook for equities is quite good.

Oil, on the other hand, reflects mostly immediate, near-term supply and demand. If the economy gets worse before it gets better, stocks might see the light at the end of the tunnel, but oil won't. It can't. Prices will keep falling as demand deteriorates in real time and the current supply glut gets worse.
Remember, oil is expensive to store. For the most part, it won't just sit around waiting to be used if there is a lack of demand. (Some can be stored, but not that much). It must be sold and used at whatever the current clearing price is.
And we have yet to see the magnitude of supply cutbacks in the oil market that we've seen in aluminum, copper and other commodities. The world is continuing to pump out millions and millions of barrels of oil.

Here are a few facts to consider:

• Oil has averaged a nominal price above $50/barrel in just three years in the history of the world: 2005 ($50.04/barrel), 2006 ($58.30/barrel) and 2007 ($64.20/barrel).
• On an inflation-adjusted basis, oil has averaged an annual price above $50/barrel for just 12 of the 62 years of the post-war era.
• The average inflation-adjusted price of oil in the post-war era is $33.65/barrel.
• Oil traded below $25/barrel as recently as 2002.
  

As the saying goes, "This time it's different" are the four most-expensive words in investing. So why not $25/barrel oil?

I was amazed during the recent oil price retreat how quick people were to say that $100/barrel was the "right" price for oil. $100/barrel is off the charts historically, and completely neglects both the supply and demand impacts that high oil prices have.

To put it another way, stock prices are now trading where they were in 1997. What's to say oil shouldn't be trading where it was in 2002?
The truth is, I have no idea where oil prices are headed. But I don't think it's a gimme that they're going back to $100/barrel. In fact, if you gave me 2-1 odds, I'd bet they hit $25/barrel first.

P.S.: One more thought about oil. Even if you strongly disagree with me and think crude oil is a screaming buy, please be careful before you buy a crude oil futures ETF like the US Oil Fund (NYSEArca: USO). Oil is in a violent contango. A fund like USO faces a 3% monthly headwind from contango right now, meaning oil prices must rise about 3% each month just to offset the losses from rolling contracts forward. Until that situation is reversed, investing in crude oil futures could be challenging... even if I'm wrong about crude oil prices.

Will Liberals Finally Unseat Tories?

Those of us in America with investments in Canroys have been more than disinterested bystanders when it comes to the Canadian Parliament. PM Harper's Tory (Conservative) party decided in October 2006 to break promises to its constituents and begin taxing the profits of Canadian Royalty Trusts. This devestated the valuations of all Canroys. The oil and gas trusts, which are also treated as non-taxable trusts in America (under the concept of Master Limited Partnerships), were especially hard-hit as there was no precedent for taxing the income of asset trusts.

Those of us invested in Canroys were outraged, though the Americans among us could do nothing about it. But the Canadians can, and apparently will. In today's Globe and on the CBC website, I found an article that the Liberal and NDP (New Democratic Party) parties have agreed to form a coalition that will force out the ruling Tory party, Finance Minister Flaherty and PM Harper. While there is no guarantee that the Liberals will roll back the law change regarding taxation of Canroys, there have been indications that the taxes will at least be modified. At this time of decreasing oil prices, we need all the help we can get to support the price of Canroy shares.

Here is the article in total:

http://www.cbc.ca/canada/story/2008/11/30/canada-coalition.html?ref=rss

A Floor Under the Price of Oil (and Gas)

This article demonstrates what we have always discussed regarding the floor on the price of oil. As compared to the early 80s when relatively high prices encouraged exploration around the world for easy to develop oil glutting the market, new discoveries are in hard to reach places, like 10,000 to 20,000 feet under the ocean. Even though the discoveries in deep water the past few years add to the known world oil supply, they will not get developed at lower (current) prices. This means we are stuck with the lower cost reserves that are dwindling around the world.

The Alberta oil fields are relatively inexpensive to develop and produce. They are generally profitable at $30-40 / barrel, depending on the formation and the oil quality (the amount of stimulation required to get it out of the ground). The really cheap oil that is profitable at $10 / barrel is just about gone in North America (light sweet crude near the surface, like West Texas crude, or "Jed Clampett" crude as I call it). So, when you hear people talk about oil going back to under $20 / barrel, they really don't know what they are talking about.

Some of the more adventerous or less proven drillers are not a good idea right now. But PWE, PVX and PGH have very good operations that don't have many questions.

Also, see www.mcdep.com for his educated opinions on the status of the oil market.

I have attached an article from Barrons Online titled "The Downturn's Impact on One Oil Driller, Callon Petroleum gets a downgrade after it blames economy for decision to terminate project."

"The Downturn\'s Impact on One Oil Driller";

CALLON PETROLEUM (Ticker: CPE) announced that it has decided to indefinitely suspend development of the Entrada field, located in the deepwater Gulf of Mexico. Management cited the recent collapse in oil and gas prices and higher-than-expected development costs as the reasons for terminating the project.

To date, Callon has successfully drilled two exploration wells at this field. The third well recently reached a total depth of 21,100 feet but needs to be sidetracked.

In March 2007, after owning 20% of Entrada, Callon acquired the remaining 80% interest from BP PLC (BP) for $150 million. Subsequently, in the first quarter of 2008, Callon sold 50% of the field to Japan's ITOCHU Corp. for $155 million, with Callon remaining the operator. At the time of the divestiture, Callon estimated Entrada's development costs to be approximately $300 million.

At year-end 2007, Entrada had an estimated 192 billions of cubic feet equivalent (Bcfe) of proved reserves (a total of 339.6 Bcfe of proved plus probable reserves). After adjusting for the divestiture, Callon's pro forma year-end proved reserves were 168 Bcfe. Therefore, approximately 57% (96 Bcfe) of the company's total proved reserves are now uneconomic in the current commodity price environment.

The field was expected to begin initial production in the first half of 2009. With the project now halted, we are lowering our earnings estimates, and our proved net asset value also decreases accordingly. Entrada was expected to double the company's production rate, and without this new source of cash flow, Callon will likely be forced to make major cuts in its capital budget for 2009.

After two years of planning, the suspension of the development of this large asset is a very negative event for the company. Ultimately, Callon may have the opportunity to divest its remaining interest to a company that has the balance sheet to see the project through to its conclusion, but in the near term, Entrada's economic value has diminished considerably. Based on the potential for a large reserve write-down, the minimal visibility on production growth, and the uncertainty about the company's post-Entrada operating strategy, we are downgrading Callon Petroleum shares from Market Perform to Underperform.

Paul McCullough Proclaims the Fed on the Right Track

Check out this morning's CNBC appearance by Paul McCullough. He is one of PIMCO's three leaders, that includes Bill Gross and Mohamed El-Erian (who left PIMCO to be Harvard Trust Fund's manager of $38B, but came back to PIMCO and is highly respected). The three of these guys don't get it wrong too often.

http://www.cnbc.com/id/15840232?video=938759900

So, if we are in for a period of stabilization due to the pouring on of liquidity into our financial system, and then due for some significant inflation to pay for all that stimulation needed to save the financial system and home values, we should be positioned accordingly with our portfolios. And because this has been our thesis for the past year or more, we are.

But I never thought we would go through this severe a deflationary recession to get to the expansionary inflation; only talked about it as a remote possibility since I thought the Fed / Treasury knew enough history to avoid it. Bernanke undoubtedly does. But don't underestimate the ability of the Congress to get in the way of solving our national problems. They have no trouble getting us in (way too loose regulation on lending / banking and way too socialist in home lending policy), but want to find someone else to blame when the stuff hits the fan (I am thinking of a certain Sen. Barney (Fife) Frank).

Thinking about how to lever up at these depressed stock price levels leads me to two of the Proshares ETFs: DIG and UYM. Both use leverage to get 150% of the Dow Sector index. Here is a sampling of their holdings and performance (naturally, miserable the past few months):

UYM

http://profunds.com/ProFundsProfiles/FundID_402/Basic_Materials/Profile.fs

DIG

http://profunds.com/ProFundsProfiles/FundID_413/Oil_and_Gas/Profile.fs

Off the Charts Bad

The past week has brought the stock market, actually all investing markets, to the worst place they have been, by many measures, in recorded history. This is actually encouraging. If it is this bad, how much worse can it get? And we are all still standing, so we should congratulate ourselves for that not-so-minor accomplishment.

How bad has it been? From today's Barrons, here are some quotes from Michael Santoli:

"The virtually unwitnessed level of damage in a short period almost defies hyperbole. After Thursday's drop to an 11-year low on the S&P 500, the index was farther below its all-time high than at any time since 1949. The year 2008, had it ended then, would rank as the worst since 1872 at least. The S&P hadn't been as far below its 200-day average since 1932. Nearly 40% of S&P 500 stocks were below $4 billion in market capitalization, the minimum new stocks must meet to be added to the index. More than 40% of the stocks in the Russell 3000 were trading below $10."

"Investment-grade corporate bonds have outperformed stocks since 1980. The S&P 500's indicated dividend yield rose above the 10-year Treasury yield for the first time since around the time the Giants and Colts faced off in their classic 1958 championship game."

Yesterday, I blogged the opinions of super-Bear Marc Faber who is finally calling for an end to the crash. Other long-time bears, even perma-bears like Jim Rogers, David Tice and Peter Schiff, are calling for more of the same. Technician Louise Yamada is calling for a low around 400 to 600 on the S&P500, which is another 50% drop from where we are today. All of these are forecasts are possible, but are they likely? It seems that even if market cycles are never the same, at least they rhyme. The two major historical references are the twin 1930s declines and the twin late 60s and early 70s declines. The path from here is likely to be similar to the aftermath of both periods.

And from another article, an interview with Robert Fetch, are similar sentiments:

"...the market is clearly discounting a fairly severe recession. There's a good chance that before this is done, the S&P will make a new low. When the S&P went below 804 last week, the percentage decline off the highs marked the greatest bear market in history since the Great Depression." "You have the capacity right now, as a value manager, to find good, solid low-valued stocks of good companies without having to pay a premium for them for the first time, really, since the early 1980s".

What marked both the 1932 and the 1974 market bottoms and resulting economic declines, was a government led effort to restimulate the economy which eventually led to a dynamic market environment. The two periods had different political settings. 1932 marked a three year period under President Hoover where the government did nothing while the markets and economy declined. Hoover and the Congress were following "Laissez Faire" (hands off) economic policies under the theory that market economies would heal themselves without government assistance. It proved to be a painfully incorrect theory.

It wasn't until FDR took office in early 1933 (March back in that time), that the New Deal was born and the government poured money into the economy with the goal of re-employing people to alleviate the very high 25% unemployment of the period. In hindsight, economists, led by Milton Friedman, have shown that had the initial response to the 1929 market crash and resultant asset deflation been more aggressively reflationary (aka stimulation through low interest rates and work programs), the worst of the Great Depression might have been avoided. In any case, investing in the market in early 1933 would have proved very beneficial, even given the 1937 correction, severe in its own right.

The 1968 and 1974 twin crashes were a little different, politically. 1968 was brought on by the uncertainty around civil upheaval caused primarily by the Vietnam war and two major political assinations (Martin Luther King, Jr. and Robert Kennedy) coinciding with a blowoff top of the 60s tech bubble. Thereafter were several years of economic gyrations and failed government policy as indicated by the collapse of the gold standard and the 1972 wage-price freeze to contain inflation. Then in 1973 came the OPEC oil crisis and gasoline rationing accompanied by a 400% spike in oil and gas prices. The proverbial straw came with the Nixon Watergate scandal and his subsequent impeachment.

But unlike 1932-33, the market collapse in 1973-74 did not coincide with a Presidential election. Instead, we had Gerald Ford serving essentially two years of a lame duck Presidency, during which nothing significant could be accomplished in Congress or the Administration to repair the economy. Under Jimmy Carter, there were efforts to stimulate the economy which worked to some degree. But the stimulation in the vicinity of high oil prices, caused massive inflation by 1978. Then came round two of OPEC's assault on the Western world's economies. High oil and gas prices in 1978-79 caused another significant recession and 20% market decline which was eventually resolved by Paul Volcker's attack on inflation and then the Great Bull Market of 1982-2000.

It is clear to me that we can rely on one of these two precedents to forecast the next 5-10 years in the markets. As pointed out before, even if history does not repeat, it rhymes. Here is a chart comparing the three periods in question that makes that point:

If we are at the end of 1932, just prior to the inauguration of a new Democratic President with a mandate to fix the economy and get people back to work, we can look at a market run 0f over 400% between February 1933 and February 1937. If instead, we are at May 1938, we can look at a 50% run over the next 16 months. After the market peaked in October 1939, the fear over WW2 stopped the market ascent and it went sideways until February 1945, near the end of the war.

If, as I think we are, at the market bottom of September 1974, on the heals of Nixon's impeachment in August, we can have at least a 70% run over the next two years as we did until the uncertainty over the 1976 election stopped the run up that summer. But because the market crash has coincided with the Presidential election, we may have a much more robust recovery in the market and economy than in 1974-76. Barak Obama has already promised to rebuild the national infrastructure to put people to work. This will be his New New Deal. The resulting spending will pump a lot of money into the economy, will lower unemployment and eventually improve the consumer spending outlook.

If the last scenario is correct, what will benefit? Infrastructure, materials and energy companies. The improving consumer will also benefit the developing export-driven economies in Asia and restart the Chinese economy (further increasing demand for infrastructure materials and services). Some names that look interesting, all down 60-80% from their peaks, are engineering companies: JEC, FLR and URS; Materials stocks: CX, BHP, FCX, NUE; Energy stocks: PWE, MRO, PVX, SU; and Asia stocks: FXI, IFN and TDF.

I already own most of the above, and have held them through this decline for better or worse (mostly worse as of late). But the case for infrastructure is better than ever. Now the above stocks are dirt cheap by every fundamental metric. Even if the timing of the recovery of the market is off by 6 months or a year and there is more decline to come in the immediate future, held over a 5 to 10 year time frame, the above will reward.

Good investing!

"Dr. Doom" Marc Faber calls for a Huge Market Rally

There is a certain Marc Faber, who is an anti-American Swiss national, living in Hong Kong, who has long called for the demise of the American stock market and the US dollar. He is interviewed in Barrons's regularly, and is a member of that journal's elite "Investor Roundtable".

Last night (Friday morning Europe time), he gave an interview where he is calling for a huge rebound in the stock market, and a collapse of the US Treasury bond market and US dollar, in response to the current market decline and the monetary expansion to prop up the economy. This is the scenario that I am positioned for, with big holdings in Canadian energy (non-US denominated) and material stocks and funds.

He did end his interview with an ominous warning that if the monetary expansion / reflation does not work, then we will experience a tremendous depression, worse than the 1930s. But this is how he got his title: "Dr. Doom"

Here are some of his quotes. You can see his interview on the right hand bar of this webpage.

"The sheer amount of money governments are pumping into the financial system will eventually lead to a very strong rally in beaten-down assets (aka energy), investor Marc Faber said on CNBC Friday.

But Faber also warned that if the markets remain depressed as liquidity increases the result could be a depression worse than in 1929. (don't know how this could happen...they seem mutually exclusive...either you have an asset deflation-based depression, or inflation. If it turns to hyper-inflation and worthless currency, ala Germany in the 20s or Argentina in the 70s, it would destabilize the economy, but would not be called "a depression").

By and large asset markets are "terribly oversold" now, while investors are going overboard into the U.S. dollar and U.S. Treasurys, Faber, editor of the Gloom, Boom & Doom Report, told "Squawk Box Europe."

"What you could see in the next three months is a very strong rebound in asset markets, in equities, followed by a selloff in bonds and eventually a selloff in the dollar," he said.
Governments and central banks around the world are providing liquidity and that will eventually have an impact, Faber said.

And once the buying starts the rally is likely to be "stronger than people expect" given that financial institutions are sitting on so much cash, he added.

'Colossal Deflation'

"I think the intervention by the government in the past and at the present time has created more volatility, not less, and so right now we have deflation, we have colossal deflation in asset prices," he said, noting that equities alone have lost $30 trillion globally.

But "I assure you if you throw enough money at the system, eventually you can reflate, especially in the United States," Faber added.

Statistically a rebound should happen, but if it doesn't "the air is out" and the world faces an economy "worse than the depression of '29 to '32," he said.

Is there a Rainbow somewhere?

All:

This has been a very tough few weeks. As bad as the market was at the beginning of the year through the middle of March, this is much worse. Now the economy has joined housing in the dumpster. And with a vaccuum in government between the Presidents, the timing could not be worse (I wonder if it is any coincidence that previous major market bottoms in 1932 and 1974 were during Presidential transitions, as well).

I still plan to review some of my small cap favorites and their Q3 reports. There is a lot of good news there that makes me more optimistic after reading the reports. I will try to get to it over the Thanksgiving Holiday, if not sooner. But for a quick overview: the Canroys and the high dividend closed end funds that have just been hammered by hedge fund redemptions and the changing currency situation, continue to have decent earnings and cash flows. None of my high dividend funds has had to cut its dividend yet. That time may come, but there is so much fear built into the prices now, that I am convinced they will weather the storm nicely.

As the high dividend funds / Canroys dip in price, but continue to yield high monthly income, I just reinvest it into the stocks to average down my cost. This way, when the eventual / inevitable rebound comes, my performance versus cost basis will be that much more fantastic. I will have a lower cost but also a lot more shares. And, if worse comes to worse, and they rebound no time soon because the economy goes nowhere, I may have those dividends to help pay my monthly expenses in the event of unemployment! Hope that last one doesn't come true, but we can never know the future....

I continue to think this economic and market situation is most like the mid 1970s. Then as now, we had an unpopular President (Nixon) forced out of office after an unpopular war (Vietnam), which put the country in a generally bad mood. Then as now, we had a massive oil shock that crunched the economy after many years of above average times, making the change in mood that much more dramatic. Then as now, there was a fundamental shift in the manufacturing / auto sector and the creation of new country markets that put pressure on global materials supplies (Japan, Germany, S. Korea, etc). It took us 8 years, till 1982 to recover from the 73/74 crisis. The best investment place to be during that period was in materials and energy stocks, which can withstand and even thrive during a period of weak economic performance, deficit spending and global inflation.

I am copying yesterday's edition of the Prudent Speculator that I receive. First, John Buckingham who runs the newsletter and fund is a common sense kind of guy who keeps his cool. Second, he references quotations from Steve Leuthold, who is a local (Mpls) market forecaster with a very good long term track record. So that is worth reading on its own. Good investing!!


The Prudent Speculator - Wednesday Evening Hotline: November 19, 2008

*** Executive Summary 11/19/08 ***
Near-Term Woes - Retesting the Lows
Long-Term Opportunities - What Does History Say?
Sales - Closed Out ASYT, PLAB & THC
Partial Sale - Sold 50% of ASEI at $71.20 for Certain Accounts
Hotline Special - Buy DAR up to $5.46

Another horrendous day in the equity markets, with the 'modest' 5% decline in the Dow Jones Industrial Average masking the damage done to the overall market as evidenced by a 7.9% plunge in the Russell 2000 small-cap index and the 7.4% drubbing suffered by the S&P MidCap 400. The advance/decline line was ugly as well with preliminary readings showing only 192 winners on the New York Stock Exchange compared to 3,001 losers. The numbers were not quite as bad on the Nasdaq, but a 326/2,524 ratio was dismal as well.

While the catalysts for the giant selloff included renewed concerns about the viability of Citigroup (C - $6.40) and the U.S. auto industry as well as the Commerce Department's report that housing starts fell 4.5% on a sequential basis to a seasonally adjusted 791,000 annual level that is now 38% below the reading a year ago, the Federal Reserve received a lot of the blame as the minutes of the Federal Open Market Committee (FOMC) meeting on October 28-29 were released this morning.

It shouldn't have been a big surprise that the FOMC "generally expected the economy to contract moderately in the second half of 2008 and the first half of 2009, and agreed that the downside risks to growth have increased." This is consistent with the view of many economists, though the participants did lower their collective forecast for growth in 2009 to between negative 0.2% and positive 1.1%. Of course, we would argue that the massive decline seen in equities over the past year might suggest a far worse economic environment than what the FOMC is projecting. Clearly, unemployment will continue to rise into the new year, and the FOMC now predicts that the jobless rate will average 7.1% to 7.5% in 2009, but, again, we believe that the stock markets have priced in a substantial higher number.

Despite our continued optimism for the long-term, we realize that with fear running rampant these days and it unlikely that economic or corporate news will be uplifting in the near term, we have to brace ourselves for more volatility and the likelihood for additional weakness in the short run. Having said that, the technical indicators we look at are about as oversold as they have ever been, suggesting that we are overdue for a significant bounce. For example, the S&P 500 is now 35.5% below its 200-day moving average while the Russell 2000 is 39.0% below its 200-day moving average. Those figures stood at 34.1% and 35.4%, respectively, when stocks began a six-day rally on October 27 which took the S&P 500 up more than 18% from 849 to 1006. During that same time-span, the Russell 2000 rebounded from 448 to 546, or more than 21%. In addition, the Volatility Index (VIX) hit 74 today, not far from the record close of 80 seen on October 27.

We always operate with a long-term, three-to-five year investment time horizon and we continue to think that this period of time will be looked back upon in subsequent years as one of the best buying opportunities in stock market history. As 71-year-old money manager Steve Leuthold said in his latest investor letter, dated October 28:

"If the current U.S. recession (which got underway about a year ago) is about 20 months in duration (our estimate), it would be the longest recession since WWII (average being 11 months). As a leading economic indicator, the stock market would begin to rebound in November 2008, per our historical economic time clock.

"Today's stock market, per our valuation benchmarks (P/E ratios, Price to Sales ratio, Price to Cash Flow ratio, et. al.), is quite undervalued, in the low 15% of our 60 year valuation history. From current valuation levels, the stock market has returned an average of 40% over the subsequent two years and 66% over the subsequent three years, historically.

Obviously, there can never be any guarantee that history will repeat, and we realize that many folks think that this time is different, but we've survived 1987, 1990, 1998 and 2002 by continuing to adhere to the Al Frank strategy of buying and holding broadly diversified portfolio of undervalued stocks. And the market as a whole has persevered through numerous crises with equities seeing long-term returns on the order of 10% to 12%, dating back to the 1920s.

Of course, despite our long-term optimism, we do realize that the companies we own must make it through the near term in order to participate in the eventual recovery. Though we know from experience that the biggest losers going into a bear market are often the biggest winners coming out, we have become more critical of some of the names we hold, opting to sell these stocks a bit quicker than we might have in a more 'normal' market and economic environment. With so many other undervalued stocks available for purchase, we prefer to slowly redeploy these proceeds into other bargains that might offer a little better reward/risk profile.

For example, yesterday we decided to part ways with Asyst Technologies (ASYT - $0.24) and Photronics (PLAB - $0.47), two struggling semiconductor capital equipment companies. With the odds of bankruptcy having risen dramatically, we sold ASYT at $0.23 and PLAB for $0.54. Both companies are presently spilling red ink and with conditions in the tech sector having deteriorated in recent weeks, we are worried that high debt levels may be very problematic.

With the prognosis for hospital owner Tenet Healthcare (THC - $1.46) looking increasingly dire, we decided to finally lay our position to rest this week. In its most recently reported quarter, the company reported that it ailments were becoming more malignant. Bad debt from patients is hovering at 8% of sales, and services are steadily becoming less profitable as a higher percentage of them are to Medicare, Medicade or uninsured patients. Because Tenet depends on more commercially insured patients (admissions of which fell more than 3%), layoffs and the economic downturn have pressured occupancy down to one of the lowest in the industry. With negative tangible book value and debt of $10 per share, we decided to let our THC shares go yesterday at $1.72.

Given the low share prices for the three sales, the value of the holdings at this stage of the game were not enough to move the proverbial needle in terms of performance going forward. Such was not the case for our final sale as Mark Mowrey explains…

In an environment such as this, it's vastly more difficult to justify holding sizable positions in winning stocks with rich valuations, especially when one considers the multitude of inexpensive alternatives into which one can funnel the gains. 'Course it's also tough to move money out of a stock that's been bucking the general trend downward. A smart value investor will put prudence above cupidity, nonetheless, as we did with our holdings of American Science & Engineering (ASEI - $68.04), half of our stake in which we sold yesterday for no less than $71.20 per share for those portfolios where the position was more than 1.3 times the 'normal' size. For Mowrey Portfolio Compiler and Buckingham Portfolio we received $71.25 for the shares sold, while Al received a penny more for TPS Portfolio.

The generally lumpy revenue series took a turn up for American Science in the latest quarter, as the traveler, parcel and cargo inspection systems seller gained further traction in sales of its z-backscatter systems, which produce photo-realistic images of items baddies are carrying or shipping but should not be. Service revenues were higher, too, on account of a higher total number of systems in operation. Margins were on the rise as well.

Meantime, the sales pipeline has continued to grow - backlog is at a record high - as the company targets new markets for products like the z-backscatter vans, intended for use in force protection, counter-drug and anti-terrorism applications. And with intentions here and abroad to further border protection efforts, the long-term outlook is pretty grand.

And, yet, given current market valuation metrics, this stock seems already to have priced in a good portion of that eventual growth, trading at 36 times trailing earnings and more than three times revenue. A price-to-book value measure of 3.6 times is similarly rich, most comparisons considered.

Tempting as it was to hold fast to the shares and hope for greater gains on the whole position, we found it better to sell a chunk of our holdings in ASEI to reduce some of the risk that the rosy picture will fade. The remaining shares we'll hold for a revised-higher target FG price of $78 as the balance sheet is pristine with over $10 per share in cash, net of debt, and fiscal 2009 (ends 3/09) earnings are expected to jump to more than $3.00 per share from the current trailing-12-month tally of $1.87.

Eric Hare pens this evening's Hotline Special on Darling International (DAR - $3.60)…
Darling currently operates in two segments and has been at it since its founding in 1882. Its first segment is the rendering services business, where Darling collects and processes animal by-products, converting them into useable oils and proteins that are needed in the agricultural leather and oleo-chemical industries. Darling collects these by-products from grocery stores, butcher shops and meat/poultry processors. The finished products that Darling delivers via animal parts are pretty impressive. Using meat and bone they can make anything from pet food to fertilizer, using grease they can deliver animal feed and bio-fuels and using tallow Darling can assist in the making of numerous consumer goods.

The second segment, restaurant services, involves the collection of used cooking oils from restaurants and recycling them into high-energy animal feed ingredients and industrial oils. The need for this service is high, as it allows for restaurants to be more productive as it helps streamline the kitchen cleaning process.

A large portion of the by-products from rendering are high growth markets. Demand for new bio-fuels continues to grow and with the new administration starting in January, we’d expect it to at least stay the same. Furthermore, Darling does wonders for the environment. The recycling of fat and protein through the rendering process significantly lowers the amount of green house gas that would have been emitted.

Darling operates all over the world, with the United States providing the majority of its revenue. As a global provider with a proven aptitude in acquiring and synergizing other companies, Darling has an ability to scale the business and offer better prices to customers than any of its regional competitors. The revenue breakout is about 73% rendering and 27% restaurant services.

Operating margins favor the rendering segment as the most recent quarter saw a figure of 19.7% compared with 15.3% for the restaurant services. In addition, margins are improving as the prices at which the by-products can be sold have outpaced the increased manufacturing costs. In the most recent quarter, Darling earned $0.28 per share which compares favorably with the year prior where it earned $0.15. Revenue over the same period jumped to $236 million from $171 million.

A knock on Darling is that its business is capital intensive. The company has to constantly maintain/replace its large fleet of vehicles and heavy equipment for rendering and processing plants. That said, Darling is financially sound, sporting strong free cash flow, a good interest coverage ratio and a net cash position. Management has done a tremendous job of using the strong cash flow to pay down debt and accumulate cash as just last September Darling was showing a long-term debt number that was ten times its cash position.

The valuation for Darling is enticing as it trades for 4.5 times trailing-12-month earnings and for 35% of sales. We recognize that earnings will decline in 2009, but we think that that the nearly 80% decline in the share price since the end of July has been overdone. For those who share our long-term, three-to-five year investment time horizon, we are buyers of DAR up to $5.46 based on an LG/FG pair of $10/$11.

Earnings Season: AMS reports results

Back from two weeks of hectic travel, I have some time to go over my investment portfolio. I like the way it is set up right now. I am out of most of the more dangerous plays I was in over the past 12-15 months, especially in the financial sector. Most of what I have now is energy, primarily Canroys, emerging market funds and small cap high tech and medical plays.

Because the small caps typically report 4-6 weeks after the end of a quarter, it is just now that we are able to review the 3rd quarter results for the small cap stocks, including the Canroys. I will go over my favorites the next few days, in separate reports. From what I have seen, I am very happy with the performance of my picks.

First, I would like to take a look at American Shared Hospital Systems (AMS). This "microcap" has a market cap of only around $8M. It has 5M shares outstanding, but $10M in cash. So, it has more cash than market cap, which would be great under any circumstances (some of this cash will be used to service loan payments). Today (Monday) you can buy a share for $1.50, give or take. Being this small, it takes very little buying or selling action to move the price. A buy of $5,000 for 3500 shares, will have a material impact on price. The price moves by 10-20% almost every day. It was as low as $1.01 on Oct. 10.

But there is a lot more to this company than cash on hand. It also owns many radiation therapy machines of different types, which it has leased to major cancer treatment hospitals for their tumor therapy centers. Currently, AMS has $45M of assets on its balance sheet for equipment at medical centers, this is net of depreciation. So, on the $8M market cap, there is a lot of financial leverage in the form of equipment owned and under lease. But there is almost no risk of default considering to whom that equipment is leased. The leases cover the depreciable life of the equipment. There is zero residual value at the end of the term.

Against the leases, securities and cash is $22M in long term debt and another $13M in short term or current debt that is completely covered by cash on hand. This all leaves a very healthy $20M of shareholder equity or book value (assets less liabilities) that is 1/2 in cash. With the current market cap of $8M, AMS is selling at less than 50% of tangible book value, which is cheap in any era, the 1930s or the 2000s. The Directors like their own stock and announced on the investor conference call they will buy back 500K shares, or 10% of stock outstanding, which will support the stock price.

Oh, one other thing, there are $1.5M in preferred shares listed under assets. These are the Still River Systems shares and account for about 20% of SRS's equity. SRS has a decent chance to become a major player in radiation therapy, alongside Siemens, Varian and Phillips Medical. That position alone could someday be worth more than 10X the current AMS stock price ($80M). This stock is a bargain by any standard. Check it out: http://www.ashs.com/investors.html

The Great Debate: Is the Fed Too Loose or Too Tight?

I have had a running debate with other blogsters regarding the current Fed policy of loose money. Being a student of history, especially the Great Depression, I know that one of the biggest factors contributing to the Depression was the fact a conservative (Hoover-led) government, Treasury and Federal Reserve kept money tight after the stock market broke down in October 1929. In fact, the Fed raised its Federal Funds rate in 1930 as it reacted to the perceived inflationary threat showing up in reports from data generated in 1928 and 1929 during the Roaring 20s Bubble.

I have contended that as assets aggressively contract, primarily real estate the past two years, some offset is needed to balance the national books. Otherwise, we have a deflation by definition (to little money chasing too many goods) and deflation is never a good thing as it causes people to save excessively (hoard) and not spend. This stops the economy and also feeds on itself. Some of my blog opponents feel that we should just let Free Markets work; that the market will do a better job of solving our problems than government. But history shows otherwise. A free market is a great thing during normal times, but it is too severe a master during times of stress.

To help me make my point, I am borrowing a column from "Barrons Online" posted yesterday. It says all that I have been trying to say, but more eloquently. Here it is:

TUESDAY, OCTOBER 28, 2008
UP AND DOWN WALL STREET DAILY

Pushing on a String or at the End of Their Rope?
By RANDALL W. FORSYTH

Sado-monetarists decry the doubling of the Fed's balance sheet, but is it enough?

THE FEDERAL OPEN MARKET COMMITTEE begins a two-day policy meeting Tuesday amid what now is conceded to be the worst financial crisis since 1930s. And, as in the Great Depression, the U.S. central bank is being criticized for being too easy and risking inflation amidst a severe debt deflation.

The Fed has doubled the size of its balance sheet in just seven weeks to attack the crisis. That has elicited squawks from what Barron's much-missed late friend and colleague, John Liscio, called the "sado-monetarists" who think that the central bank's efforts to cushion the pain of credit contraction invariably puts us on the road to perdition. As when he coined the phrase back in the early 1990s, the Fed is expanding its credit to offset the contraction in credit in the private sector.

Michael T. Darda, chief economist of MKM Partners, notes the Fed has expanded its balance sheet by $900 billion since early September, a seeming eternity ago when the Mets were cruising to the post-season and temperatures were sizzling. But that seemingly Zimbabwe-like 206% annual rate of increase in the Fed's assets in the latest 26 weeks hasn't ignited a monetary inflation. Quite the opposite, in fact.

A record percentage -- nearly 25% -- of the high-powered money the Fed has provided effectively sit idle as excess reserves, Darda points out. In other words, banks are sitting on a huge precautionary cushion. Banks are hoarding cash and are loath to lend to each other except for overnight periods.

That means banks are unlikely to unleash a new, inflationary wave of lending; quite the opposite. Yet the high levels of excess reserves in 1937 caused the sado-monetarists of the day to sound the inflation alarm back then and spur the Fed to tighten. That aborted the recovery and extended the depression, resulting in a resumption of the bear market. (Note: check out long term stock price charts and you will clearly see how the stock market cratered in 1937 due to this Fed tightening).

This time around, the deflationary symptoms are everywhere. Industrial commodity prices have been halved while the 30-year Treasury bond yield has sunk to its lowest level ever, under 4% last week. Gold has plunged to around $700 an ounce from $1,000 while the dollar has surged. And risky asset classes have melted down, he notes.

While the Fed is pumping more reserves into the banking system, less is being transformed into broad money and credit. And that money is turning over more slowly (velocity is falling, to use the economists' jargon.) The combination renders Fed policy "far less potent than it would otherwise be," Darda concludes.

That leaves the question, what's the FOMC to do at this point? The consensus of Fed watchers and the futures market is that the panel will cut its federal-funds rate target another 50 basis points (half percentage point) to 1% when it announces its decision Wednesday at 2:15 PM EDT. That would leave the Fed's main policy rate at its previous nadir touched in the past cycle and would, in effect, leave it relatively few basis points left to cut before the funds rate reached zero.

"The question is what the Fed does next," write ISI's Washington policy analysts, Tom Gallagher, Andy Laperriere and Melissa Loesberg. "We think it might have one more conventional rate cut before resorting to unconventional measures. But the real answer is that the Fed will wait for fiscal policymakers to take their turn," they conclude. (Note: this will come in the form of another national "special rebate" of around $1000-1500 that will be passed by Congress during a special session in November and distributed in time to impact Christmas spending, so I predict).

Goldman Sachs' economists also look for a 50 basis point cut from the FOMC but think a 75-basis-point slash, halving the fed-funds rate to 0.75%, is a 33% possibility. An important factor in the FOMC's decision will be the results of the Fed's latest quarterly survey of bank loan officers, which Goldman notes the policy makers will have in hand. This survey, taken in September, will be made public next month. The previous survey released in August showed a sharp tightening in credit standards for consumer, mortgage and business loans.

In other words, the Fed has been pushing on a proverbial string.
More than pure quantitative measures, price indicators show persistent credit tightness. Spreads between market interest rates and risk-free or administered rates have come in from their peaks, but remain elevated.

In particular, the three-month London interbank rate has come down to around 3.50% as of Monday, from the peak of about 4.80% on Oct. 10, but this benchmark remains above the 2.80% that prevailed in September before the Lehman bankruptcy and the Fed's 50-basis-point cut, to 1.5%, on Oct. 8. (Note: Why is Libor still so high, when the Fed keeps pushing the Funds Rate lower? The answer is that banks don't want to lend to each other, or are afraid to, after so much bank carnage. This means that what interbank lending does occur, does so at a higher interest rate than in a freer, less risky market. This impacts us because Libor is the index for many consumer loans and mortgages, and is also a barometer of economic health).

Three-month Libor also remains elevated against OIS -- the overnight interbank swap rate, which reflects the market's view on the fed-funds effective rate. The Libor-OIS spread is down to 263 basis points from a peak of 366 basis points on Oct. 10. But before the crisis, when banks were willing to lend to each other, Libor-OIS was a relatively trivial handful of basis points.

Getting Libor down is a more important, though less visible aim of the FOMC. The Fed's program to purchase commercial paper, which commenced Monday, should take further pressure off the money market. The Fed initially set a rate of 1.88% for top-grade three-month paper Monday, far below Libor, which should help to continue pull the interbank rate lower, according to Banc of America Securities' head of credit research, Jeffrey Rosenberg.

The Fed's unprecedented push of liquidity may have nearly doubled its balance sheet but it still has not offset the private sector's need, according to Bridgewater Associates. The world has accumulated so many dollar debts, and the ability to refinance and expand these debts was so ingrained in the financial system that its breakdown requires an unprecedented response from the Fed. But with so much of the global financial system out of the reach of central banks, the risks to policy makers are numerous.

With debt deflation engulfing the credit markets and the economy here and abroad, the sado-monetarists should get over their Whip Inflation Now fetishes.

After the Bottom, Then What?

Some day soon, maybe today, maybe in a month, the stock market will find its bottom. Some technicians are predicting 7500, which is the same as the market lows in July 2002 and March 2003. Those form a natural line of resistance for the DJI. Others, like Art Cashin, the CNBC old-timer floor trader, thinks it might be 7000. It is very unlikely the market would crash down to 5000 or 4000. That would require the economic depression scenario, since it will require much lower aggregate corporate earnings to drive stock prices that low. Most think a depression is possible only if the global bankers do not respond with aggressive money creation. So far, the central bankers have responded.

What will be the investment class that does best coming out of the market slump? If you think that all the liquification to unfreeze the financial markets comes with the price of much higher inflation, as I do, then the best place to be will be asset classes that benefit from inflation: hard assets / commodities.

Have you noticed how the global deflationary environment rewards currencies that are doing the most to reinflate their economies, like Japan and the USA? The dollar has soared the past two months from $1.60USD per 1 Euro, to $1.20USD to 1 Euro, a 25% move. The turnaround in Japan is even more dramatic. The yen is now trading at 92Y per $1USD while it was at 120Y per $1USD just a few months ago. The Euro has weakened against the Dollar and the Dollar against the Yen. The Euro has weakend by 40% to the Yen in just a few months. Amazing! And disruptive! How can Japanese export goods compete in Europe after such a currency move? The answer is, they can't. This is why the Japanese Nikkei stock index dropped to a 26 year low today.

This is all about the unwinding of the "Yen Carry Trade" where global investors borrowed the very cheap yen, with interest rates in Japan at only 0.5%, and loaned the same money in other countries at much higher rates, or used the funds to finance commodities futures transactions, which helped drive up commodity prices. With the trade now in full-speed reverse, all that borrowed money is flowing back to the Yen as traders and hedge funds sell their positions and repay their Yen borrowings. As they do so, they convert some / most of their Yen back to US dollars, which strengthens the dollar. Because they are preparing for fund redemptions, they put the funds in very short term, super safe US Treasury bills. This causes competition for Treasury bills causing the interest rates on those instruments to drop to ridiculous low levels of less than 0.25%.

Even the Canadian dollar has gotten into the game, and has gone from parity at $1C per $1USD to $0.78C to $1USD in just a couple months.

On this last point, it has made the performance of the Canroys and other Canadian stocks more dismal when converted to $USD. My Canroy stocks, like Pennwest, Pengrowth, Provident, Canadian National Resources and Daylight Energy, are all down 50% or more the past two months. So is DHG, the closed end high dividend fund that is heavily invested in Canroys. About 1/3 of this decline, though, is the exchange rate. The other 2/3 of the decline can be attributed to the decline in the price of oil, which itself is because of the unwinding of hedge and mutual fund positions. That is a temporary phenomena, so long as I don't have to sell. Since mine are (now) completely unlevered retirement funds, I can hang on till the environment changes. Most of the Emerging Market stocks (Brazil, Mexico, Russia, etc) share with Canada their reliance on commodities for their economy and currency strength. So, emerging markets will also benefit from a global change in sentiment.

What will cause this change? Reflation. Once the markets, and then the economy, bottom, and economic growth reappears here in the USA, but even more dramatically in the emerging markets, global demand will once again increase for all things commodity: energy, grain, metals, chemicals and gold. I do not believe that the global banking system is nimble enough to take all the liquidity back out of the market that has been put in to save the financial system, as fast as will be necessary to avoid inflation. I think inflation, maybe relatively high inflation of over 5%, is a certainty within 24 months. The pain to avoid inflation will politically be just too great, as it will require buying back the financial instruments issued to flood the economy with money. When central banks buy back financial instruments, they raise interest rates in the process and make capital more scarce. It will be hard to take actions that will hurt the economy almost as soon as it starts to get repaired.

So, if you can stomach the volatility, and if you are still invested today, then I guess you have proven you can, hang on to your energy and commodity stocks. If possible, buy more, or at least reinvest dividends to capture more stock at the current low prices. The next couple years will not be much fund. But eventually the sun will shine. And if the 1970s are any precedent, it will shine most brightly on asset classes that benefit from too many dollars chasing too few goods.

Bill Gross, the oft quoted chairman of PIMCO Advisors and global bond guru, agrees with this perspective. Today on CNBC he made took a similar position (I was just happy to be aligned with his perspective, certainly not the other way around). I have posted his appearance for your viewing pleasure (see right hand bar).

www.cnbc.com/id/15840232?video=906626482

What is Next for our Economy and Currency?

Reading Barrons today, I came across a good piece by editor Thomas Dolan. It reflects on where we are as a nation and world in respect to our economic system(s). It questions what will be the new-world order for exchange. I will paraphrase and add my own comments:

""The worst financial crisis since the Great Depression is claiming another casualty: American-style capitalism." The French president, Nicolas Sarkozy, has announced, with neither a trace of an accent nor a trace of sarcasm, that "Laissez-faire is finished."" And that is good, isn't it? Laissez-faire as a recipy for economic disaster. Humans are driven by greed and fear. Left alone in a capitalist economic system, people will try to maximize their own personal gain at the expense of their fellow man, the definition of greed. SOME regulation is required to keep man from hurting himself in his primative drive for economic gain.

As Dolan quotes and interprets, correctly in my opinion: "In one of the more lucid passages of Das Kapital, Karl Marx said, "In every stockjobbing swindle everyone knows that some time or other the crash must come, but every one hopes that it may fall on the head of his neighbor, after he himself has caught the shower of gold and placed it in safety. 'Après moi le déluge!' is the watchword of every capitalist and of every capitalist nation.""

America is painted by some as the land of greed, and in fact, many in this land act greedily and without regard for their fellow man, as will most people given the opportunity and means, and with NO limits or regulation. It did not help that after World War 2, America's was the only significant economy left standing in the world. Because America had the only functioning industrial complex, by lieu of geographic isolation and friendly status with the border nations of Mexico and Canada, when world finance leaders met in New Hampshire in 1944 to repair the world financial system, the decision was made to index all other currencies to the US Dollar, and the dollar to gold in what was called "Bretton Woods".

http://en.wikipedia.org/wiki/Bretton_Woods_system

As Thomas Dolan continues: "(The agreements reached at "Bretton Woods" were) dictated by the United States. It reflected the astounding dominance of America in the world economy (near the end of) World War II. The U.S. accounted for 40% of global economic output and had at least 80% of the gold reserves. Only the dollar was credible enough to be pegged to gold; other currencies could be pegged to the dollar. Thus, the U.S. became the world's creator and judge of money."

"The U.S. eventually abused its power to create the world's money, flooding the globe with unwanted dollars in such profusion (during the Johnson Presidency years of "guns and butter" during Vietnam and civil unrest), that it couldn't redeem them for gold (when foreign Central Banks so tried in 1971). In 1971 (the US governmnet) admitted that, went off the gold standard and left the world and itself with no restraints on the creation of money and credit."

I don't think it is possible to go back on the gold standard, nor is it wise. Gold and other forms of hard asset economic regulation do not reflect the ability of mankind to grow its economic value. Humans are creative and productive. We can make more with less as we apply intellect to practical problems of life. A currency fixed to a finite amount of gold does not reflect this fundamental truth. This is why gold as financial proxy does not now and never has worked.

What is needed is a GLOBAL method to measure in real time, human productivity and growth, and index the sum of tradable financial instruments to the sum of all productive capacity. This will allow economic growth without artificial restraint, but will also allow expansion without risk of inflation and currency devaluation. Accompanying this new form of financial index should be investing and banking regulations that are tight enough to ensure transparency of all financial structures and transactions, along with limits to leverage; but still loose enough so as to not choke off risk taking that leads to economic expansion and opportunities for everyone.

How can this be done across all economies around the planet? Greater minds than mine will need to figure this out. But it is worthy for global leaders to try to find a way. Do we need a Bretton Woods 3?

Buffett Believes in America, Shouldn't We?

This editorial from the NY Times has already received a lot of public attention. But in case you did not have a chance to read it in full, I thought I would make it available to you. I have my arguments with Buffett on his politics, but regarding his investing acumen, there is no doubt.

If American stocks are good enough for him now, they are certainly good enough for me. So I am 100% invested in the stock market as of today, mostly large cap, secure and high dividend producing stocks and mostly in the energy / commodities space, since I am fairly certain we will have price inflation in commodities when the economy rebounds.

"Buy American. I Am. "
http://www.nytimes.com/2008/10/17/opinion/17buffett.html

By WARREN E. BUFFETT
Published: October 16, 2008

THE financial world is a mess, both in the United States and abroad. Its problems, moreover, have been leaking into the general economy, and the leaks are now turning into a gusher. In the near term, unemployment will rise, business activity will falter and headlines will continue to be scary.

So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds. (This description leaves aside my Berkshire Hathaway holdings, which are all committed to philanthropy.) If prices keep looking attractive, my non-Berkshire net worth will soon be 100 percent in United States equities.

Why?

A simple rule dictates my buying: Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors. To be sure, investors are right to be wary of highly leveraged entities or businesses in weak competitive positions. But fears regarding the long-term prosperity of the nation’s many sound companies make no sense. These businesses will indeed suffer earnings hiccups, as they always have. But most major companies will be setting new profit records 5, 10 and 20 years from now.

Let me be clear on one point: I can’t predict the short-term movements of the stock market. I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over.

A little history here: During the Depression, the Dow hit its low, 41, on July 8, 1932. Economic conditions, though, kept deteriorating until Franklin D. Roosevelt took office in March 1933. By that time, the market had already advanced 30 percent. Or think back to the early days of World War II, when things were going badly for the United States in Europe and the Pacific. The market hit bottom in April 1942, well before Allied fortunes turned. Again, in the early 1980s, the time to buy stocks was when inflation raged and the economy was in the tank. In short, bad news is an investor’s best friend. It lets you buy a slice of America’s future at a marked-down price.

Over the long term, the stock market news will be good. In the 20th century, the United States endured two world wars and other traumatic and expensive military conflicts; the Depression; a dozen or so recessions and financial panics; oil shocks; a flu epidemic; and the resignation of a disgraced president. Yet the Dow rose from 66 to 11,497.

You might think it would have been impossible for an investor to lose money during a century marked by such an extraordinary gain. But some investors did. The hapless ones bought stocks only when they felt comfort in doing so and then proceeded to sell when the headlines made them queasy.

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. Indeed, the policies that government will follow in its efforts to alleviate the current crisis will probably prove inflationary and therefore accelerate declines in the real value of cash accounts.

Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky’s advice: “I skate to where the puck is going to be, not to where it has been.”

I don’t like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I’ll follow the lead of a restaurant that opened in an empty bank building and then advertised: “Put your mouth where your money was.” Today my money and my mouth both say equities.

Warren E. Buffett is the chief executive of Berkshire Hathaway, a diversified holding company.

Here is What is Wrong with our Economy

Rep. John Culberson came on Fast Money today and showed us why we are in an economic disaster. Watch and listen to this guy. He doesn't understand what he is saying and shows he is incapable of even listening to the experts on the show. We have no chance if this is who we have running our country.

http://www.cnbc.com/id/15840232?video=872233203&play=1

The Deal is Done

Monday morning, Sept 29, and the Deal is Done. We are going to get our $700B "bailout" of the American, if not world, financial system. But is this too little, too late to save the economy. This is what we have yet to find out.

There is no doubt in my mind, that if a deal hadn't been done by last night, we would have had an immediate devastation of the world stock markets. The backstop of the financial system will just allow the air to be let out of the balloon more gradually and less catastrophically. But the market is headed lower, maybe much lower, as the full effect of financial deleveraging and consumer angst is felt.

Another theme is developing: we will have many fewer banks in the next year, than we have had in the recent past. There is a deliberate effort by the Treasury and FDIC to consolidate banking assets to a few strong, or less weak, banks so that the crisis can be better managed. The "chosen ones" are apparently: USBank, Wells Fargo, JP Morgan, CITI and Bank of America. Goldman Sachs can also be added to the list as the only major investment banker left standing. I am somewhat vindicated in that I have long said (since last August) that I thought BAC and C would be considered "too big to fail" and would be protected by the Feds. I have to admit, though, that I have lost some money on this bet as even when I am right about their solvency, I have been wrong about the stock price.

All other banks are at risk. We know this because of the pattern that is developing. The FDIC just can't afford any more IndyMacs, which went bust in an uncontrolled way, leaving FDIC on the hook for $14B (or so) of insured deposits. FDIC only has around $45B of assets, so it can't afford to have all the banks go bust without some pre-emptive efforts. In the past week, it has overseen the dissolution of WaMu (assets only assumed by JP Morgan) and now, today, Wachovia (assets and liabilities assumed by Citi). Both banks were heavily exposed to the residential mortgage market.

On the investment banking side, Bear Stearns and Lehman have already been taken out with the help of Federal agencies. Morgan Stanley took itself out by selling itself off to Mitsubishi Bank.

What is next? The wave of banking failures is spreading around the world. Fortis and another less well know British bank were also dissolved over the weekend with assets transferred by European banking authorities. There is plenty of toxic exposure in China and other major Asian economies. The total effect of all this banking damage will be very negative for the world economy for many quarters to come. The markets must take a hit to reflect this reality.

Advice: it is too late to run for the exits, IMO. But, a little short side protection on existing positions is called for. I will buy SDS, the inverse and doubled short on the S&P500 index, in the next couple days. There may be an additional benefit of this action as I think when the Short Sale prohibition on many Financials comes off next week, that short positions may pop as a result of pent up demand into such a weak market.

A Look Back to Help Find the Way Forward

I have spent some time during recent days in remorse. "How did I not see all of this coming and get into cash?", I ask myself. But I am being unfair to myself, because I did see all of this coming, but could not bring myself to believe that it would actually happen or pull the trigger to sell out and get 100% into cash.

I looked to see what I was saying in January 2004, and low and behold, I thought all of this was a possibility, though in early 2004 I did not yet fully appreciate how much the real estate bubble would affect the future. By the end of 2005, I understood that was the true danger. But if our financial system was not so inherently weak prior to that bubble, it would not have brought the system down. Looking back on this advice, it sounds as relevant today, as it did almost five years ago.

Here is what I said in my annual letter, January 2004:

REAL ASSETS

This category was not mentioned in previous reports, but is an area of great interest. The base materials (natural resources) markets have outperformed many equities and all bonds in 2003. Gold, like oil and other natural resources, has reversed a 25 year downtrend. This is very significant. It was only two years ago that many central banks decided to liquidate gold reserves, pressuring prices with the anticipation of increased supplies. Now, gold has gone from $250, to well over $400/oz. in 18 months. What does this mean? Is it a portent of things to come? Gold has been the “Anti-dollar” since 1971, when the USA (and by extension, any central bank with currency linked to the dollar) went off the gold standard and onto a paper based standard (the USD). Gold prices went from $35 in 1971 and eventually to $850 in 1980, during the height of inflation. Then as now, gold strengthens when the dollar (and other paper currency) weakens, as gold is the alternate form of world financial exchange.

Gold and other commodity prices are considered by many economists to be predictors of future inflation. Inflation is created by excess debt leading to declining currency valuation. If government and consumer debt and money supply is again in excess, then inflation and declining purchase power of the USD is on the way (Boy, sure got this one right!!). The deficit spending of the past 3 years rivals the late 60s, during Johnson’s “Guns and Butter” program, as a percent of GNP. But the story is really worse this time. Unlike the 60s, when the USA was still the world’s creditor nation coming out of World War 2, with positive balance of trade, now, the USA has severely negative balance of trade. Continued build up of national and personal debt is doubly troublesome. Unlike the 1970s, now have nothing to offset our debt, except more paper.

Potential “Doomsday” scenarios come out of this ominous situation. At best, as hoped for by me, the large national debt will result in a price inflation, a stagnant economy, flat stock market, and declining bond prices in concert with increasing interest rates. See the 1970s for an example. I believe this is what the Fed is now trying to engineer: dollar devaluation and price inflation. The dollar devaluation makes exports more attractive and imports less attractive, helping our trade balance. Price inflation reduces the impact of long-term debt for both government and consumer at the expense of the creditors: mortgage holders in the case of consumer debt and foreigners in the case of government Treasury bonds.

In the worst case scenario, the dollar’s value will disintegrate taking the USA and many other dollar-denominated economies with, leading to a global financial crisis and depression that could last for 10 or more years. From this depression will emerge a new global financial power, China, which would de-link its currency from the USD, and make the China Yuan as the new global currency standard. As the new creditor power, replacing the USA role from the 50s and 60s, China will dictate world policy.

The end result of these concerns is the need to own either commodities in the form of mining, energy or other natural resource companies, and rare metals: gold, silver, platinum, etc, in certificate or in fact.

Energy stocks are another commodity that would do well in an international financial crisis. Asia (China) continues to increase consumption of energy products, like oil and coal. Supply is limited and requires years of effort to expand. Commodities will also do well during a period of global inflation, or deflation, as during the 30s. Raw material values may not increase in absolute terms during periods of deflation, but they do not decrease much, either. So, if currencies increase in value, as they do during a period of deflation, then commodities appreciate in relative terms.

Hold on for a Ride Up

Looking at the market before the open this morning, of course I wish I had a lot more Financial stocks than I do. The UYG and XLF will explode higher this morning. I had been short financials by selling the puts of SKF, a short fund. But I closed out my position yesterday because I hoped the actions that took place would happen. I closed it with SKF running very high on fear at $140. Today, SKF may open below $90. Boy, that was close. That would have been expenisve if I had not gotten out yesterday.

Meanwhile, the very large Goldman Sachs position I hold is looking a lot better. It was trading as low as $85 midday yesterday. I own it at $172 (actually, the options, but the loss would be the same). Today, it looks like it will open above $140 and could go to $160 during the day, getting me back close to even.

So, though I won't have a chance to get back into my long UYG position (the opposite of SKF), because it is soaring in the pre-market, I am happy for what I have. Hopefully you will also have a very nice market day with the action in front of us.

Be glad you are not a professional short seller with big short positions in Financials (hedge funds, Al Queda?) They will be wiped out if naked (not covered by equal long positions)