Friday, October 31, 2008

Taxation and Pensions

State and local governments cannot print their way out of budget issues like Uncle Sam, but they CAN get bailed out by Uncle Sam.  (Be careful what you ask for, you may GET it.)

Much of the cause of this tsunami of tax increase proposals is due to the Obama phenomenon. Political consultants have told their clients in government that this is an ideal time to put tax measures on the ballot because the presidential candidate is driving low-income voters to the polls who will be inclined to support higher taxes for those they see as more prosperous than themselves.  

Cynical politicians have gleefully taken the advice, and are proceeding with a policy that can best be summed up as -- with apologies to Admiral Farragut -- "Damn the economy! Full taxation ahead!" How else can they ignore the fact that our state is in a recession and taxpayers are in a vise?
Politics really does have a significant effect on production, savings, spending, etc... (Your politics may or may not be offended by the above... TFB.  It is what it is.)

Let us take California as an example:

CA is going to go 60/40 for a liberal Democrat.  This same plurality has elected a legislature that has led CA to ruin.  This is not a coincidence.  Balancing tax revenues with spending is IMPOSSIBLE when your constituency is the "give it away life should be fair" Left, and, as we have seen from the Bush Administration, no piece of cake for the "Tough Love" Right, either.

In the final analysis (and you ain't gonna like this one bit) the Left is not employed (for the VAST most part) in enterprise, law enforcement (ever met a Liberal State Trooper?),  the military (ever met a Liberal Special Forces Operative?)... any more than the Right is employed in Academia or Social Work.

Taxes, my friends, flow from tax payers (The Right) to tax receivers (The Left).  This battle has been joined since free market capitalism raised its head from conception of the Industrial Revolution.  The problem is, the energy crisis is not in the business of taking political prisoners.  Does anybody really think that the collapse of suburban housing values and the decline in Oil imports into the U.S. are not cause and effect (or effect and cause in this case, respectively)?

Americans are going to have to go to work,  produce REAL goods (and services) export those goods (and services) and they are going to have to SAVE some of their hard earned money in the form of under-consumption.  You are going to have to pay your OWN WAY.  The credit/energy crisis facing Americans is going to reduce the number of "RICH" by a significant margin.  The middle and working classes consume the vast majority of services, they will, by mathematical necessity be required to pay for it.

The problem at the state and local level is not that the "RICH" are being taxed to little, it is that the state and local governments have over promised/over committed on pensions to government retirees, as well as over promised "services".

We have more police, fire protection, trash pickup, parks, etc... than we can afford to pay for.  Simple as that.  We are not addicted to Oil so much as we are addicted to economic growth and the taxes collected as a result.  It does not matter "WHY", or "WHO", any more.  "SHOULD" does not matter any more, either.  WE WILL spend less on these services, we will STIFF the beneficiaries of these local and state pensions (one way or another), and the Federal Government WILL bailout the pension system.

Only when they bailout the pension system they will bailout EVERYBODY... Everybody will get some of that pension money.  This accomplishes some key goals for the government.  The U.S. needs INFLATION - BAD.  Instead of sending out $600 checks to everybody, the government can bailout the pension system by promising everybody that paid taxes a pension.  This way they will not be in the position of asking the have nots - taxpayers - to bailout the haves - local, state, corporate, etc... retirees.  The have nots will not go for it.  The government NEEDS to inflate.

This is going to happen, one way or another.  

Mentatt (at) yahoo (d0t) com

Thursday, October 30, 2008

More on those soon to be non existent pensions

Here is a link to an excellent sight call the "pensiontsunami".

All of the big pension funds have invested oodles of capital in private equity funds and investment hedge funds.  If you think hedge funds have been cleared out, wait till you get a load of what the private equity guys have done to their investors.

These guys have outdone Religion in the "False Promises, Manipulation, and Exaggerated Claims" department.  I did not know that was even possible.

But I digress...

Private equity used leverage that would scare the snot out of a drunken hedge fund manager, and hedgies have notoriously strong constitutions.  And these guys are PANICKED.  I love reading their BS... "structural issues", "strategic unwinding" (whenever you hear strategic, check for your wallet and your watch), "debt restructuring".... these guys are doomed, and their investors are, too.  That would be your kid's schoolteacher, the fireman that just got the cat out of your tree, and the cop working the cross walk.  These are the beneficiaries of those pensions.

But notice a similarity between these folks?  They work for local and state GOVERNMENTS.  If THEIR investments go south... NO PROBLEM - they will simply extract it BY FORCE from homeowners, business owners, and other tax payers.  Or at least that was the plan.  Unfortunately, the massive recession we are looking into ass end of as we speak is going to trash that idea.    People will simply not be able to pay.  So the Fed and the Treasury will have to step in, AGAIN.

Hmmm...  Interest rates are going down, the federal budget deficit is rising briskly, employment (productivity) is going down, and the Federal Government is printing money like there is no tomorrow.  

Brother, can you spare a (silver) dime?

Waiting in the wings is an energy shortage that is going to finish off in the economy what the credit crisis left standing.

This is it.  There will likely be NO MORE "REAL" ECONOMIC GROWTH in the U.S. (+ or - 3 years, though there might be some inflation masquerading as growth).  What will a static state economy be like?  How will capital move in such a system?  WHAT WILL HOLD VALUE?

Good Luck!

Mentatt (at) yahoo (d0t) com

Wednesday, October 29, 2008

The Pension Crisis Cometh

So, you have a pension... From whom?

Think, if you will, of the political implications of that.  Picture this:

John Q. Public, many of whom have no health insurance or pension, are going to be asked to bailout the pension benefits of Corporate and Municipal retirees!  How do you think THAT is going to go over?

Not good, indeed.  Not good at all.

Mentatt (at) yahoo (d0t) com

Tuesday, October 28, 2008

Injection, Rejection, Disection, Reflection

The following is a guest post by someone who wishes to remain anonymous (I only WISH I could take credit). I will only say that he is an exceedingly bright (perhaps more than that) PhD type with a background in Economics, Mathematics, and Computer Science.

Credit Contraction, US Economy, Markets

The markets and the economy are dependent on government action, as without it the banking system would already have effectively stopped functioning. In addition to numerous measures by the Fed, the Congress has approved a $700B rescue plan. So far $250B has been approved for release, of which $125B is agreed upon on is being released to banks this week. However the $250B will not adequately address the banks’ problems.

If the US government puts only $250B in banking system, US banks would have to shrink their credit outstanding by over 50% . This would result in a decrease of at least 25% of total credit in the economy, as bank lending makes up about half of total credit. Given the relation of credit growth to economic growth, and to the markets, we could see the following :

- Economic contraction of 20%
- Stock market fair value would be down 60%
- Move from previous market top to new bottom: 70%

But given political realities, there will likely be delay in expansion beyond the initial $250B. So the credit crisis will continue causing significant GDP contraction, downward pressure on equity and commodity prices, and upward pressure on USD. Eventually Congress (perhaps the new Congress) will authorize additional bank funds, some likely “earmarked” for specific purposes (e.g. auto loans, home loans, consumer lending). At this point banks may receive another $250B, bringing their total to $500B.

If the US government puts a total of $500B in banking system, commercial banks would be able to maintain their existing credit levels, exclusive of the former investment banks. The effect of eliminating the former investment banks would shrink total credit by about $2.6T, which represents about 10% of the total credit in the economy. The net effects of this credit reduction could be as much as

- Economic contraction of 8%
- Stock market fair value down 24%
- Move from previous market top to new bottom: 42%

But given that the markets are already down close to 40% from their highs, moves below this level may not be sustainable and would be reversed after the second $250B to banks. However stock market values will also be affected by economic growth prospects and potential additional investor risk perception and aversion.

In addition to the bank rescue plans, the US government will likely also greatly increase spending programs to counteract the economic slowdown. The combined effects of Fed and Treasury moves and government spending plans will be that USD money supply contraction will be arrested and USD and commodity prices will stabilize. Of course US government debt will increase substantially.

At this point policy makers may recognize that inflation is a way to reduce the real burden of the debt.

And they may also recognize a need, or at least a benefit, to re-inflate the markets, given

- Private pension funds had $3.1T of equities as of 3Q07
- State and local government pension funds had $2.1T of equities as of 3Q07
- Life insurance companies had $1.5T of equities as of 3Q07

And all of these are likely far below where they need to be to meet projected requirements.

That leaves us with a couple of big questions:

- Will increased government borrowing and spending re-ignite USD inflation, or will economic malaise result in the Japanese model of ongoing deflation

o If inflation:
§ Rates for treasuries will increase
§ USD will lose value in real terms
o If deflation
§ Rates for treasuries will stay low
§ USD may still lose value vs other currencies as potential carry trade currency

- Will China and other big buyers of US treasuries invest more in their own economies rather than support US borrowing?

o If local investment over US treasury debt
§ USD will lose value
§ US rates will have upward pressure
o If continued buying of US treasury debt
§ USD will be supported
§ US rates will have downward pressure

To both of these big questions, the first answer is the more likely.

Appendix 1: US Bank data

- Mortgage-related writedowns likely to be in $1.4T to $1.7T range (10% to 12% of total)

o Using 2005 and 2006 data, with 2004 adjustment: $1.35T to $1.725T
o Using total non-prime market estimates: $1.6T
- Less than $600B has been written down through 2008 3rd quarter, primarily by
investment banks marking to market

- According to Federal Reserve statistics, as of June 2008, US Commercial
banks have the following:

o Assets: $11,694B
§ Mortgage assets: $3,662B (31%)
§ Bank Loans: $2,108B (18%)
§ Consumer credit: $813B (7%)
o Liabilities: $11,362B
o Total Equity (assets – liabilities): $332B
o Applying 10% writedown to mortgage assets, 5% to Bank Loans and Consumer
Credit, assets are reduced by over $500B (~4.5%), completely erasing total
o US Commercial banking system is insolvent as a whole

- In 3rd quarter 2008 investment banking system has been largely incorporated
into the commercial banking system with Merrill Lynch purchased by Bank of
America, and both Morgan Stanley and Goldman Sachs reclassified as bank
holding companies
o At end of 2nd quarter securities brokers and dealers had:
§ Assets $2882B (including “miscellaneous assets” of $1603B; mortgage related
assets are not broken out separately)
§ Liabilities $2875B

- Investment banks assets will likely need significant writedowns; 10% of
miscellaneous assets, the category containing mortgage assets, would be $160B
- Former investment banks will have to adhere to commercial bank capital
adequacy standards, meaning reduction in credit from $2.9T to under $0.3T or
increase in capital from $7B to $87B
- Fed injection of $160B would get them back to barely solvent, but would
require credit reduction of $2.6T
- Fed injection of another $80B would allow them to keep outstanding credit
and stay within commercial bank capital adequacy standards

- A total of $740B would be required to get the US banking system back to
where it was in the 3rd quarter of 2007 in terms of ability to support
credit in the economy. This amount does not include rescue packages for
insurers, pension funds, or other industries.

Appendix 2: Bank balance sheets; capital, assets and credit

- The vast majority of bank assets reflect credit they've extended to others
in the economy. These include mortgage debt, consumer and business loans,
as well as corporate and government bonds.
- Banks' balance sheets are identical to standard corporate balance sheets
with Assets = Liabilities plus Equities. When assets are "written down",
such as recognizing that the mortgages outstanding may not be repaid in
full, those writedowns directly impact banks' equity. This is because
banks' equity is essentially the difference between their assets and their
liabilities, and now the assets have decreased while the liabilities of
course are still the same.
- Banks' equity is also called Bank Capital. Banks' capacity to lend is based
on their capital, due to reserve and capital adequacy requirements.
- Total US commercial bank assets are approx 30 times equity (as of 2Q08),
meaning equity is just about 3% of total assets. So a writedown of 5% of
assets would completely wipe out bank capital.

Capital infusion of $250B from government to banks

- With current assets written down by $500B (see Appendix 1), infusion of $250
B reduces capital from $332 to $82B, requiring massive reduction in
commercial bank assets and the complete elimination of former investment
bank assets.
- To avoid this, the Fed, the Treasury, the FDIC, and other bank regulators
will make numerous concessionary changes:
o Capital adequacy rules will be temporarily relaxed to allow increased
o Accounting rules will be changed to allow the banks to postpone writedowns
o the Fed will pay interest on bank reserves
o the Fed will cut rates
- If capital adequacy standards are halved
o $82B capital would dictate 50% reduction in outstanding credit, in addition
to elimination of former investment bank credit, bringing total reduction to
- If accounting rule changes allow banks to postpone writedowns
o Banks will remain technically solvent but will likely curb all but the
safest lending, and will take writedowns gradually over years as capital
- If favorable Fed policies increase banks' average return on assets from 1%
to 1.5% and banks cut dividends to preserve cash
o An additional ½ to 1% of total asset value may be added to bank equity
o It would take 3 to 6 years at this rate to get to former capital levels and
- Banks are likely to get additional CD deposits due to increased risk
aversion, which would speed the bank repair process, but not help equities

Capital infusion of $500B from government to banks

- $500B will largely offset writedowns on commercial bank assets, exclusive of
former investment banks. These former investment banks were responsible
for approx 20% of bank credit outstanding as of the end of the second
quarter 2008.

Appendix 3: The impact of bank credit on the economy and the markets

- Commercial banks and investment banks are responsible for approx half of non-
governmental debt outstanding in the economy ($13.9T of approx $27T).
Every 10% reduction in commercial bank credit would constitute an overall
credit reduction of 5%.
- Since 2001, US GDP growth has been correlated to business credit growth with
GDP increasing at ~80% of the rate of business credit increase. At this
ratio, every 10% bank credit reduction would cause GDP to contract by 4%
(excluding government moves)
- Market returns average approx 3 times GDP growth.

- At these ratios, every 10% bank credit reduction drops the market value 12%.
- Then consider markets’ well-documented propensity for momentum and
- S&P 500 standard deviation is 13% to 16%. So to estimate total move from
top to bottom, start 1 standard deviation over initial fair value and
calculate move to 1 standard deviation under new fair value.

Monday, October 27, 2008

"Come In, Rambo!"

"They're all dead sir"

"Who are?"

"Delta Team, Sir."

"Not Goldman  or Morgan, they made it out alive."

"They're dead too, sir.  Got killed on Wall Street, didn't even know it."

There are NO bids on Wall Street.  There is no capital.  Fundamentals do not, and will not, work in this environment.  Even if they did, the fundamentals are not readily apparent at the moment.  This does not mean that a huge rally could not happen tomorrow.  Or a huge crash.

The big guys are gone.  Gone are the days when "Big Broker" (Goldman Sachs)'s head equity trader would stroll up to the hoot and holler box (I KNOW I am dating myself with that one), and declare they were a million share buyer for any of the following 50 names at the then and there price.

Oil?  Oil is priced by the marginal barrel of supply/demand.  Right now, who can tell what that is?  Visibility could show up tomorrow... but right now, I can't see my hand in front of my face. At the moment, Oil is following equities.  If equities were playing to Oil, equities would be going up as Oil went down.

Stocks?  Good grief, the rally could come soon in time, but far away in price - or not.  (From Dow 6000 to Dow 7200 is a 20% rally, and at this pac that could happen next week.  Does that give you any comfort?)

Bonds?  TOO LATE. 

The markets are pricing in the recession of the century, in breadth, depth, and length.  

Good Luck!

Mentatt (at) yahoo (d0t) com

Saturday, October 25, 2008

Here's The Deal

The following are some excerpts taken from a letter to our Members.   The comments have been redacted to reflect deletions of items that could be construed as trading advice...

The U.S. equity markets, commodity markets, and fixed income markets (with the exception of U.S. Treasury Debt) continued their slide into the abyss this week.

How did this come about?

The short answer - "The sub-prime mortgage crisis" - is a great sound bite, and was likely the initial catalyst, but can hardly contain within it the sheer volume of the collapse in market value that the U.S. and world markets have experienced over the past 6 weeks.

No, extreme use of LEVERAGED debt, and a little understood, humongous market of Credit Default Swaps - really just life insurance policies on all of that leveraged debt, but without benefit of knowing whether or not the party issuing your policy could actually PAY off on a claim - set off a negative feedback loop that climaxed with the world's largest banks unwilling to lend to each other in the inter-bank markets (one of the most common terms, "LIBOR" for London Interbank Offered Rate, is one such measure), as the loans are unsecured. Accordingly, any bank experiencing a "run on the bank" such as Bear Stearns, Lehman, or Washington Mutual experienced recently, would leave their interbank debts unpaid. The interbank lending market moves cash to where it is needed on any given day - corporate payrolls for example - in the financial markets. (G.E. and GOldman Sachs both needed an emergency capital raise in order to make PAYROLL, and Warren Buffet was
only too willing to provide said capital at some very agreeable terms).

Once the mortgage default rate reached a certain point (many U.S. banks appeared insolvent using the current "mark to market" accounting rules of the SEC) they stopped lending to each other. This, by itself, and in conjunction with the way money is created in our fractional reserve banking system, led to an unprecedented shortage of available U.S. dollars in the world financial system.

This, in turn, set off another negative feedback loop with a massive sell off of leveraged bets against the U.S. $ in the form of Gold, Oil, Currencies (with the exception of the Yen, as the Yen was THE currency of choice in the international carry trade because of Japan's very low interest rates). Hedge Funds and Wall Street investment banks were forced to sell these leveraged positions, and as prices fell they were forced to sell more which only further pressured prices....

With the shortage of U.S. Dollars in the system, and with no bank willing or able to lend, the U.S. Federal Reserve was forced to take the U.S. banking system, the money markets, the commercial paper markets, bank deposits, etc... (commonly referred to in the industry as "The Nuclear Option") onto its balance sheet, and the U.S. Treasury has begun to raise (monetize) debt to fund this Fed balance sheet expansion. The U.S. pension system is likely the next beneficiary of a government bailout, along with the U.S. auto manufacturers.

The total of all of the various Fed & Treasury packages is likely to exceed $3 Trillion! This number does not include the stimulus package earlier this year, or any future stimulus/rebate or deficit fiscal policy designed to further "stimulate" the economy.

At the moment, the U.S. $ is still rising against every currency (except the Yen) and commodity. The Dollar Index has risen 20% in 6 months. That means that, for dollar investors, asset prices on the other side of the trade have fallen by a similar margin (all else being equal).

Can the U.S. $ continue to rise in the face of all of this money creation by the Federal Reserve? After all, the US$ rise was caused by a shortage of $'s in the system, not increased productivity, interest rate policy, or Federal or Trade surpluses. (None of these measures would argue well for a strengthening dollar). It then follows that as the Federal Reserve and the U.S. Treasury remove the artificial shortage of US$'s in the system that the "price" of US$'s would fall.

This is not to say that the Yen and the US$ cannot continue to rise fora period of time. They can. But when the carry trade has been unwound, and the excess leverage has been liquidated, the reversal will likely be swift, sure, and brutal.

Hindsight is always 20/20. While we fully saw the near collapse of banking system, we certainly wish we had seen the US$ squeeze in advance. We did not (nor did anybody else, or it would not have happened so abruptly). But that was then, and this is now. The time to have bought US$'s (or sold assets in exchange for US$'s) was 8 weeks ago. And maybe there are a couple weeks left for that trade. But it is "long in the tooth".

We believe that certain commodities are at bargain prices, prices we will look back on and say "that was sooooo obvious..." in terms of Fall 2008 US$'s. As they say in the commodity markets: "The cure for low prices are low prices". The price of Oil, Gold, and especially Silver have gotten below the costs of producing the marginal barrel or ounce. The incentive for the energy exploration and production industry to find and produce Tar Sands, Deep Water, Coal to Liquids, etc... has been destroyed. We believe this will lead to SIGNIFICANT oil shortages in 2010 - 2012. (Supply destruction will exceed demand destruction in our opinion.)

While Gold has fallen to the year's low for Americans, Gold is trading at a record or near record price for Australians, New Zealanders, South Africans, Brazilians, Russians, and is up over 20% for Europeans, as a result of the US$ squeeze... all in the last 30 days! This has been true, to a lesser extent for Oil as well. Commodities trade relative to the currency of the purchasing country. We believe the US$ "squeeze" is temporary, and possibly short lived. The endless creation of money via the printing press and very low interest rates has never been a successful strategy for maintaining the purchasing power of a currency (in order to buy Oil, bread, steel, milk, rubber, coffee, etc...) for any country at anytime in modern history. This will not be the first, in our opinion.

Mentatt (at) yahoo (d0t) com

Monday, October 20, 2008

This is Hysterical!

You can find the following orginal article here.

If you have been reading my stuff for a while, you know how I feel about the American Aristocracy, who they are, and how they got that way - and how they nearly brought the entire financial system down recently. Well...


"From the Scorched Earth Files:

Andrew Lahde, manager of a small California hedge fund, Lahde Capital, burst into the spotlight last year after his one-year-old fund returned 866 percent betting against the subprime collapse.

Last month, he did the unthinkable -- he shut things down, claiming dealing with his bank counterparties had become too risky. Today, Lahde passed along his "goodbye" letter, a rollicking missive on everything from greed to economic philosophy. Enjoy:
Today I write not to gloat. Given the pain that nearly everyone is experiencing, that would be entirely inappropriate. Nor am I writing to make further predictions, as most of my forecasts in previous letters have unfolded or are in the process of unfolding. Instead, I am writing to say goodbye.

Recently, on the front page of Section C of the Wall Street Journal, a hedge fund manager who was also closing up shop (a $300 million fund), was quoted as saying, "What I have learned about the hedge fund business is that I hate it." I could not agree more with that statement. I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy, only ended up making it easier for me to find people stupid enough to take the other side of my trades. God bless America.

There are far too many people for me to sincerely thank for my success. However, I do not want to sound like a Hollywood actor accepting an award. The money was reward enough. Furthermore, the endless list those deserving thanks know who they are.

I will no longer manage money for other people or institutions. I have enough of my own wealth to manage. Some people, who think they have arrived at a reasonable estimate of my net worth, might be surprised that I would call it quits with such a small war chest. That is fine; I am content with my rewards. Moreover, I will let others try to amass nine, ten or eleven figure net worths. Meanwhile, their lives suck. Appointments back to back, booked solid for the next three months, they look forward to their two week vacation in January during which they will likely be glued to their Blackberries or other such devices. What is the point? They will all be forgotten in fifty years anyway. Steve Balmer, Steven Cohen, and Larry Ellison will all be forgotten. I do not understand the legacy thing. Nearly everyone will be forgotten. Give up on leaving your mark. Throw the Blackberry away and enjoy life.

So this is it. With all due respect, I am dropping out. Please do not expect any type of reply to emails or voicemails within normal time frames or at all. Andy Springer and his company will be handling the dissolution of the fund. And don't worry about my employees, they were always employed by Mr. Springer's company and only one (who has been well-rewarded) will lose his job.

I have no interest in any deals in which anyone would like me to participate. I truly do not have a strong opinion about any market right now, other than to say that things will continue to get worse for some time, probably years. I am content sitting on the sidelines and waiting. After all, sitting and waiting is how we made money from the subprime debacle. I now have time to repair my health, which was destroyed by the stress I layered onto myself over the past two years, as well as my entire life -- where I had to compete for spaces in universities and graduate schools, jobs and assets under management -- with those who had all the advantages (rich parents) that I did not. May meritocracy be part of a new form of government, which needs to be established.
On the issue of the U.S. Government, I would like to make a modest proposal. First, I point out the obvious flaws, whereby legislation was repeatedly brought forth to Congress over the past eight years, which would have reigned in the predatory lending practices of now mostly defunct institutions. These institutions regularly filled the coffers of both parties in return for voting down all of this legislation designed to protect the common citizen. This is an outrage, yet no one seems to know or care about it. Since Thomas Jefferson and Adam Smith passed, I would argue that there has been a dearth of worthy philosophers in this country, at least ones focused on improving government.

Capitalism worked for two hundred years, but times change, and systems become corrupt. George Soros, a man of staggering wealth, has stated that he would like to be remembered as a philosopher. My suggestion is that this great man start and sponsor a forum for great minds to come together to create a new system of government that truly represents the common man's interest, while at the same time creating rewards great enough to attract the best and brightest minds to serve in government roles without having to rely on corruption to further their interests or lifestyles. This forum could be similar to the one used to create the operating system, Linux, which competes with Microsoft's near monopoly. I believe there is an answer, but for now the system is clearly broken.

From Portfolio: Who Got Screwed in the Wall St. Bailout?

Lastly, while I still have an audience, I would like to bring attention to an alternative food and energy source. You won't see it included in BP's, "Feel good. We are working on sustainable solutions," television commercials, nor is it mentioned in ADM's similar commercials. But hemp has been used for at least 5,000 years for cloth and food, as well as just about everything that is produced from petroleum products. Hemp is not marijuana and vice versa. Hemp is the male plant and it grows like a weed, hence the slang term. The original American flag was made of hemp fiber and our Constitution was printed on paper made of hemp. It was used as recently as World War II by the U.S. Government, and then promptly made illegal after the war was won. At a time when rhetoric is flying about becoming more self-sufficient in terms of energy, why is it illegal to grow this plant in this country?

Ah, the female. The evil female plant -- marijuana. It gets you high, it makes you laugh, it does not produce a hangover. Unlike alcohol, it does not result in bar fights or wife beating. So, why is this innocuous plant illegal? Is it a gateway drug? No, that would be alcohol, which is so heavily advertised in this country. My only conclusion as to why it is illegal, is that Corporate America, which owns Congress, would rather sell you Paxil, Zoloft, Xanax and other additive drugs, than allow you to grow a plant in your home without some of the profits going into their coffers. This policy is ludicrous. It has surely contributed to our dependency on foreign energy sources. Our policies have other countries literally laughing at our stupidity, most notably Canada, as well as several European nations (both Eastern and Western). You would not know this by paying attention to U.S. media sources though, as they tend not to elaborate on who is laughing at the United States this week. Please people, let's stop the rhetoric and start thinking about how we can truly become self-sufficient.

With that I say good-bye and good luck.

All the best,

Andrew Lahde

Oil - Not Ready for Prime Time

Crude Oil, as a commodity, is a tough place to make money trading.  After all, Oil is the ultimate economic barometer, and the economy is the ultimate Oil barometer.  But right now, we don't know enough about either Oil's net production gains for 2009 or how bad the credit crisis will slow WORLD economic growth (as opposed to the U.S.).  

Oil for FRONT MONTH DELIVERY could fall below $60 by year end.  My eye is on the December 2010, 2011, and 2012 delivery contract.  Prior to the Oil run up last year Oil had been trading in backwardation (where later delivery contracts are trading for a lower price than the near month contracts), and at this moment Oil is solidly in Contango, with later delivery points higher, some of them MUCH higher (on a percentage basis).  This makes sense, if you think that the recession will end at some point in the nest 2 years.

Production of Crude & Condensate is up modestly in 2008 from 2007, with the marginal supply of ethanol, bio-fuels, and coal to liquids up sharply relative to their 2007 numbers.  Natural Gas Plant Liquids production has had a significant increase in production year over year.  2008 Gross liquids has averaged 85,788,000 barrels per day in 2008 vs. 84,408,000 in 2007 an increase of over 1.3 million barrels per day.  

So that begs the questions:

If the world has increased the total liquid's petroleum supply by 1.3 million barrels... and the U.S. is consuming 1.037 million barrels LESS... and inventories declined year over year...

Just who is out biding the U.S. for this Oil (or is it that the exporters are just consuming more of their own)?

Will "they" continue to do so?

The ability of Mexico and Venezuela to maintain their export capacity to the U.S. is questionable at best (remember, Oil is priced in US$.  Exports, or lack thereof, into the U.S. will have an exaggerated effect on world prices).  Internal consumption in the Middle East and Russia (4 of the top 5 exporters) rose over 7% last year while gross world production grew at 1.5% this year (hat's off to Robert Rapier and his r-squared blog for an excellent call here).  None of this argues for a protracted decline in Oil prices, but EVERYTHING in the short term seems to make that very argument.  

So how much of all of this is priced into the current market?  And will the futures curve steepen or flatten?  If you trade Oil and you get this right, you will wind up on the cover of Fortune Magazine.  It is setups like these that can make, or break, a career.

Good Luck!

Mentatt (at) yahoo (dot) com

Friday, October 17, 2008

The Kansas City Shuffle

The following is a guest post by my good friend, Dr. Saif K. Lalani (otherwise known to the American Energy Crisis readers as the "Mad Scientist".


I do not edit or censure any Guest's post.  The opinions expressed in this post are Dr. Lalani's alone, regardless of how much I might agree.  Nothing herein is intended as financial advice or any kind of recommendation.  So, without further mealy mouthed B.S....

The Kansas City Shuffle

“We are entering the second Great Depression. Prices will decline relentlessly for many years and unemployment will soar. Demand for commodities will wither and the Chindia Juggernaut will be stopped in its tracks…”

It is amazing that no less than 3 months back the whole world was worried about hyperinflation and the US dollar moving to parity with the Zimbabwe dollar and now...deflation and Kondrateriff Winter rules. The deflationist party is in full swing with the Fed perceived to be pushing on a string and the price of everything except credit coming down.

I think that given appropriate powers in place deflation is possible in the US. It would be healthy and purge some excesses from our system. But I think Mike Shedlock and others are dreaming if they think that we will have a protracted period of global money supply contraction. Credit standards and interest rates in the US are about as low as they can get. Not so elsewhere. Until recently it was considered a “loose lending standard” in India to give someone a loan for 50% of the property value. None of the exotic products that prevailed here have had widespread dissemination. 95% of Chinese cars are bought with full payment. 95%! Think of that. 70% of Indians and Chinese have never used a credit card and have savings over 20%. Interest rates and reserve requirements are quite high in both countries and have plenty of stimulatory potential.

Mish Continues to make the silly (to my mind) argument that is the equivalent of saying “Someday a person will die” i.e. the end is deflation. He may be right at some point but he will not be right on a global basis for a protracted period of time. Now Mish has a huge problem as he is about as deceptive as any one I know in using things to promote his point of view. When oil prices were rising he repeatedly said that rising prices are not a sign of inflation, and those that argue otherwise are stupid and do not know what inflation is. Now that prices are coming down, every post is about prices coming down - and that is supposed to be evidence of deflation.

Let us take a longer-term view. The US dollar has lost 99% of its purchasing power since 1930. Let us for argument's sake say that it gains 50% from here over 5 years before inflation sets in again. It would still have lost 98.5% of its purchasing power at its best moment. Look at what the Fed is currently doing. Look at what the U.S. Congress is doing. Another 150 billion package proposed. If that fails it will be 500 billion and then maybe a trillion. Normally issuing debt like this deflationary as the interest competes with spending, but not for the US government which spends like drunken sailors anyway.
This is the great Kansas City shuffle. Everyone and their brother is talking about deflation and the money drops are going to come in fast and furious. For a sentiment analysis I suggest you visit the A quarter ago everyone thought hyperinflation would be the end result and now everyone believes deflation cannot be helped.

Corn, Soybeans and wheat look like “bargains of the century” at these prices. Long dated futures (2011 plus) look like a sound place to start. Will write about oil in a separate article.


We have great stocks trading at 3-5 times expected earnings. Sure many estimates will come down but many will not. Those are bargains of the century. If you think that we will stop eating or using coal over the next 10 years because of “Deflation” then by all means, buy the classic 10 yr treasury bond yielding 3.5%. The long bond has peaked and we will now see yields moving past 4.5% in 1 year, in my opinion. The unlimited supply from the US Treasury and limited demand from foreigners (as they have less to recycle as we cut back spending) will guarantee that. Remember the last deflation scare in 2001-2002? 10 yr yields went as low as 3.03% and then rocketed higher.

Back to stocks...We have Ebay trading at a 30% discount to it's price in 2000. Then, it made 9 cents a share, now it made 40 cents in a quarter. Then it had 1 billion in cash, now it has more than 4 billion. Ex cash it traded at 180 times earnings, now it trades at 5 times earnings. The long bond was at 6.5% and hence Ebay was trading at a 1200% premium (in terms of earnings yield), now it trades at a 75% discount. I am not recommending Ebay… but it serves to make a great example. All my life I have hated technology stocks because of their ridiculous valuations and now I may actually buy a few.
I have taken new positions in Mosaic, Agrium, Pennwest Energy Trust and Provident Energy trusts.


The Australian dollar looks hammered. On a purchasing power parity as well as on fundamentals it looks a lot better than the US dollar. It has lost 35% (against the USD) in 3 months, which is extremely unusual for a currency with moderately good fundamentals. Many believe that with prices for commodities down that Australia exports will collapse. I doubt that that will happen over any protracted period of time. Also the amount received by Australian exporters in Australian dollars at current exchange rates is likely to be higher than 3 months ago.

In summary we are seeing massive de-leveraging, as evidenced by currencies moving 10% in a day and 87% of stocks simultaneously hitting new lows. I am quite bullish on stocks and if not for the coming implications of peak oil I would have been over-the-freaking-top bullish on stocks.

Dr. Saif K. Lalani, PhD.


Thursday, October 16, 2008

Irrational Pessimism

The U.S. equity markets are in full scale melt down mode.

Either that momentum stops here, or the U.S. pension system will be the next big bailout (even if it does stop here, that may happen).  G.M. and Ford, the UAW, CREF, etc... all have assumed 9% compounded growth out into forever, yet the equity market's have had a negative return for over 10 years, bonds have had total return over 5% during that time, Real Estate likely has, but certainly not at the moment.  This is scary stuff.

On the other hand, Stocks have been beaten down to the point where dividends actually MATTER.  This has not happened in several decades.  Companies as diverse as Pfizer (7%+), British Petroleum (7%), and G.E. (6.4%) sport dividend yields as much as 50% more than the 10 year Treasury.  Think about it: At a 7% dividend, your investment will increase over 20% in 3 years and double in 10 without benefit of capital appreciation (provided they don't CUT the dividend).  That ain't gonna happen in a checking account.

If you have been reading my stuff for a while, you know that I have been very concerned that the market's were not pricing the housing, banking, and energy issues into stock prices. Markets are discounting mechanisms.  They take in the available information and are "supposed" to reflect everything that is known about the future in the current price environment.  But the element of human emotion brings us to moments of "Irrational Pessimism" and "Irrational Exuberance".  At the moment, I cannot find any evidence that people are not at their MOST pessimistic.  Of the 5 major investment banks, 1 is bankrupt, 2 were acquired, and the remaining 2 had to convert to commercial bank status.  Hedge funds have unwound their positions (just look at the Japanese Yen... seems to me the "carry trade" has been closed).  I feel differently at Dow 8500 than Dow 14,000.

Even using a depressed earnings forecast, the S & P 500 is trading at roughly 13 - 14 times earnings.  The book value (remember that one) for the U.S. Equity market is $5 Trillion.  The total market cap is less than $10 Trillion.  We are trading at 2X book currently.  In 1999 the U.S. was trading at 5X book.

Could things get worse?  They could, but my bet is we are a great deal closer to a bottom in equities than a top.  And if they do get worse?  That would mean a crippling recession takes place, with implications for the value of the currency and sovereign debt.  The banking system MUST function or we might as well shut out the lights.  Again, my bet is that the banking system WILL function.

It is important to keep in mind that EVERYTHING is NOMINAL.  You can't invest, spend, hold, or earn REAL dollars.  The value of the $, relative to the things it can buy, is not static.  It changes.  The MASSIVE amount of increased money supply MUST be considered.  I cannot foresee an outcome that is not extremely affected by this. 

The energy supply crunch that looms before us has serious implications.  These cannot be underestimated.  But with the right leadership much of this can be overcome.  After all, does driving around in circles really benefit GDP? (Some would argue that it does, as it contributes to impulse retail buying.  But do we need more consumer behavior, or more PRODUCTION?)  A massive build out in electric rail, wind, solar, nuclear, hydro, etc... would keep us pretty busy for the next 20 years or so, and if you look at the Natural Gas production numbers, it would seem that this has real potential to get us over the hump.

So, no, the world is not coming to an end.  That does not mean that if one does stupid things: Over spends, over borrows, does not save, have no contingency plans, etc... that YOUR world might not come to an end.  Ever hear the saying "the harder I work the luckier I get"? The last 30 years have been an incredibly easy time to be lucky with out the "work" part.  That is coming to a halt.

Kuntsler's "Long Emergency", or my "Age of Personal Responsibility", or Mish's "The Future is Frugality", pretty much sum up our individual views of a post petroleum future.  Opportunities abound, as do risks.  Those that interpret their environment correctly will enjoy a better standard of living than those that do not.

Good Luck!

Mentatt (at) yahoo (d0t) com

Wednesday, October 15, 2008

This Is Bad

Every 4 years Americans convene to select a new president.  We  painfully examine the backgrounds and pedigrees of several dozen experienced politicians.  Nothing is off the table: sexual peccadillo's, drug use, SAT scores, military experience, educational achievement, etc... 

Then, with solemn demeanor we cast our votes....

And elect the tallest guy.

Dear Mr President (Obama):

The U.S. equity markets have lost over $9 TRILLION in value.  

The U.S. housing equity has lost over $4 TRILLION in value.

The U.S. Commodity markets have lost over $500 BILLION in futures contract value.

We, as a nation are MUCH poorer than just 1 year ago.  This is very serious stuff.  There ARE no rich to tax into submission anymore, and even if the government were to be so silly as to try to RAISE taxes, most folks have tax losses to carry forward for YEARS.

The good news is you will be able to take credit for the eventual recovery in the markets during the first years of your initial term, but won't be able to take credit for lower gasoline prices (that will have happened by January 20th).  

We can make real progress if you level with the American people (and if you stiff your supporters, all of whom are standing at the trough eagerly awaiting their reward) about our energy predicament.  We have had a U.S. Department of Energy for 31 years now, a huge rambling bureaucracy that cost plenty and does nothing - oil imports were less than 25% at the time of the U.S. Dept. of Energy's founding and are now over 65% (and falling, though not due to any positive action of our own, but from constrictions in the availability of surplus Oil in the exporting nations).

The economy is in need of fiscal stimulus, the monetary stimulus has prevented an immediate collapse, but if the government raises taxes now IT WILL BE LIGHT'S OUT.

Lastly, just one quick question:

If raising taxes is a bad idea in a shrinking economy... Why is it a good idea otherwise?*

Mentatt (at) yahoo (d0t) com

* To raise money to pay your constituents at the expense of the other guy's supporters.  It was a rhetorical question, after all.

Tuesday, October 14, 2008

My Point Exactly

China's Oil imports for September 2008 were up 10% over September 2007.  So much for a contraction in the Chinese economy.

There IS NO DEMAND DESTRUCTION in China, India, or the Middle East.  Russia? I doubt it, but we will have to wait for up to date data.  The imports the U.S. is NOT getting are instead going to China.  This what the talking heads are referring to when the spout "demand destruction".  

Mentatt (at) yahoo (dot) com

Where We Are, Where Will We Be?

Let us recap where we are:

The U.S. banking system nearly failed, and it nearly dragged the entire world banking system down with it.  Americans, being Americans, tend to view the cause and the culprits through the prism of their politics.  Above all, they never see themselves within the vision.

It was the Fed's fault.  It was GWB's fault.  It was Greenspan's fault.  No, wait... it was Bill Clinton's fault...  Bull S%$t!  

The seeds for this near miss of a major Depression (and we will likely miss it - for now) were sown in the last Great Depression, watered and cultivated through the creation of Medicare, Social Security, Student Loans, Medicaid, Fannie Mae, Freddie Mac, etc... and last but not least, the Department of Defense.  These are the entities and programs that have led America to the rim of the volcano, and the Great Oil Crisis of 2010 (or 2011) is going to push us into the burning lava.

If you think the U.S. is addicted to Oil... think again.  THAT addiction PALES in comparison to our real addiction - cheap Social Services financed with borrowed money that NONE OF US has ANY INTENTION of paying back. The concept that this was a good, just, and fair idea comes courtesy of the LOOOOOONEY Political Left, with plenty of help from the nose picking Right.

Talk about HYPOCRISY!!!!!  

But now it all comes down to PERSONAL RESPONSIBILITY.  The U.S. is experiencing a rapid decline in the availability of IMPORTED OIL.  This trend WILL CONTINUE.  If it continues at the pace of 2008's decline, we will be in ARMAGEDDON mode in less than 5 years.  Pray that the 9.2% decline in Oil imports for 2008 from 2007 does not continue next year (and I don't THINK it will, but...).  The rest of the world is not experiencing recession - just the U.S., the Euro zone, and the Anglo world.  China, India, Viet Nam, Brazil, etc... are EXPANDING their economies, growing their vehicle fleet (burning more oil) and their populations (eating more food and consuming more commodities).  By mathematical NECESSITY the U.S. will import less oil as these nations import more oil, because the TOTAL supply of Oil in the world has not increased.  Does your job depend on transportation (commuting).  Do your customers/clients?  Doesn't the value of your home DEPEND on you being able to get back and forth to it?

Maybe you think the $%^#@!! government will DO SOMETHING...

THE EMPEROR HAS NO CLOTHES!!!!!  You can mail out checks with as many zero's on them as you wish - as long as you are the government.  The checks won't bounce, but the currency will.  

The U.S. economy nearly collapsed twice in the past 2 weeks, almost taking with it your life savings, your job or business, and your future.  The energy crisis WILL DO all of those things to you, unless you make a number of VERY smart decisions.  This is a lot like surviving the FIRST wave in a tsunami.  The first wave, though devastating, is nothing like the main event, which is catastrophic.  

The World Economy is going to hit an air pocket, without question.  That air pocket may well cause a temporary decline in Oil demand/price (and it MAY NOT, too), so don't be fooled, or lulled into a false sense of security.  You have some time to act, so make your moves now.  The Oil import recession to come will make this one look like the good old days. 

Good Luck!

Mentatt (at) yahoo (dot) com

Monday, October 13, 2008

You asked for it, you got it

I think the government has proved its (there) point.  They (the various world governments) CAN inflate.

It won't be smooth - and the economy IS hurting - but when the OECD nations decide that what we need is a little inflation, sending faxes and calling your Congressman to stop the Paulson Plan is a lot like putting your finger in the proverbial dyke.

The deflation scare was SOOOOOOOO last week (month).  And those price declines in the commodity complex?  That was the forced selling of leveraged positions caused by the credit environment.  Looks like deflation.   Feels like deflation.  But not the same thing at all.  The cure for high commodity prices IS high prices, and the cure for low prices is low prices, all else being equal.  Shortages change the rules a bit.

Money is going to come out of the mattress (Treasuries and Precious Metals) until it doesn't.  If gold cannot rally in a week like last week, it will need something BIG - like hyper inflation - to do the trick.  Considering the world wide coordinated interest rate cuts and bank guarantees...

Speaking of rate cuts.  I was speaking with the mad scientist tonight.  As always, he has a decidedly non U.S. centric view of the markets that many Wall Streeters lack.  His view was that much of the rest of the world has room to lower rates between 3 and 6 %, and with a Fed Funds target of 1.5% (and actually at 1%) the U.S. does not have this arrow in its quiver.  Giving that some thought... doesn't that mean that if world Oil supplies do not increase that less oil will make it tho the U.S. because the growing economies (increasing Oil consumption) will be able to out bid the U.S.?  Hmmm...  that sounds vaguely important.


Crop prices are not sufficient to incentivize farmers to  build grain inventories, in my humble opinion (you never hear the American Socialists lambasting farmers as greedy businessmen). But with high Oil and fertilizer prices you can't have (relatively) cheap food and happy, solvent farmers. 

There are some opportunities here... for both farm land and grain futures.


The price of Oil in the short term can go down as easily as up.  Maybe easier.  That will set up the supply constraints in 2010 onward.  The costly marginal barrels will not be produced at today's prices, and the with credit constrained infrastructure will not get built.  If you want and incremental increase in Oil 5 years from today, you had better started on the field a couple of years ago.  This is like the bulge in the snake, what comes out has to go in first.


How much did the credit crisis shut down the world economy?  That is the $64 question.  Until we know the answer to that trading Oil will be like throwing darts.  Sorry, that pretty much describes trading in the best of circumstances... How about throwing darts with a blindfold on?

We need more  data.

Back soon.

Mentatt (at) yahoo (c0m)

Sunday, October 12, 2008

The IMF, Europe, and Asia... all following the U.S. Lead

I took a few days off.  I am back.

The Great Debate continues:

Deflation?  Or Deleveraging?  My bet is on the later, and we will know soon enough.  If the monetary stimulus and liquidity injections working its through our system work and re-inflate... well, we will know it was massive de-leveraging.   If not, then it was deflation.


Remember all that debate on weather or not the U.S. should "Bail Out" the banks?  Not much debate anymore.  Europe, Asia, the U.K., Australia, the IMF, etc... all seem to think we should "do something"... and now they are.

You can argue all you want about moving the world financial system away from a credit based system, but if and when you actually do it - the Great Depression will look like a warm up.  It  WILL happen at some point, but so do death and taxes.  


It would seem that the financial crisis will lead to a Democratically controlled White House, Senate, and Congress.  Though I have been a life long Republican, this might actually work out for the best.  The energy crisis is coming, and soon.  We will need a government that can get things done without having to compromise.  The Democrats are going to get an opportunity to show that they are competent, and not just reward their constituents (not that the Government will have the money to do so, but that never stopped anyone before).

I have much to say about how the Bush Admin's attempts to rally the US$ and depress Oil prices had some pretty significant unintended consequences - like a world wide financial collapse and handing the Presidency to the Dems complete with a yellow ribbon - so stay tuned.

Back soon,

Mentatt (at) yahoo (d0t) com

Wednesday, October 8, 2008

The New Tennessee Valley Authority

The O.E.C.D. and the U.S. in particular hold the seeds of their own salvation right in their hands.

The U.S., despite today's 19 million + barrel total commercial inventory build (more than half of the build was caused by the shutdown of the Colonial pipeline - I am working on the details and will post soon) will have to address the shortfall in liquid petroleum fuels sooner rather than later.  Too, the U.S will be stuck with massive deficit spending.

What to spend that deficit spending on?  
  1.  Build out the rail lines between the major cities on the east coast.
  2. Develop Tidal, Hydro, Solar and Wind electrical generation.  These could be done in small units taking advantage of ALL local and seasonal generation possibilities.
  3. Develop backup nuclear electrical generation to function when the sun does not shine and the wind refuses to blow.
  4. Improve insulation of all public buildings,  office buildings, and then homes.
  5. Develop networks for Community Supported Agriculture.
  6. Give Compact Florescent Bulbs away for free, and heavily tax the sale of incandescent bulbs.
  7. Improve the electrical grid to handle the increased load.
Cuts in spending will, of necessity, have to take place in ALL entitlement programs AND military spending.  For every BTU we generate here that can be used to run our economy means one less BTU we have to protect as "American interests".  The "peace dividend" could be substantial.

For those of you concerned about where the capital would come from:

No problem.  Grant investors tax free capital gains and dividend status in these industries for 10 years, period CERTAIN, and then stand back, or you will get run over by the capitalists on their way in.

Income redistribution is an idea whose time has come and gone.  We have a serious energy problem, and the people that solve it and the people that whine about EVERYTHING will be mutually exclusive subsets of individuals.

Back soon,

Mentatt (at) yahoo (d0t) com

Tuesday, October 7, 2008

The Markets (again)

With the Dow down another 500 points, closing under 9500, it would appear to me that the markets are experiencing the equivalent of a "run on the bank" - withdrawals are overwhelming the system.  Considering the price to sales ratios, these are MUCH more reliable than price to earnings ratios, of many of the companies I follow it seems to ME that the market is trying to price in a systemic collapse of the credit system.

The total value of the U.S. equity market has crashed, down 30% or so in the past in the past 12 months, with MOST of the decline coming since August 28, 2008.  The Standard & Poor's 500 Index is back to 1998 levels!  Since that time inflation has diluted the value of the index by over 40%.  

At 500 points per day, the market will be at ZERO in 19 days.  Somehow, at the very least I expect the rate of change to decelerate 

With U.S. Treasuries yielding less than 1% for shorter term paper, and just over 3% for 10 year+ bonds, SUBSTANTIALLY less than the rate of inflation, and with U.S. real estate in shambles, it would seem that there should be little competition for equities... yet the equity market has left little but broken glass and tire marks all over the mutilated bodies of those brave investors out bargain hunting.  What gives?

Either the credit system is broken beyond repair - which is what the U.S. equity markets appear to be trying to tell us... or, the massive amounts of liquidity being injected into the system by the various central banks and the U.S. Treasury will unclog the system.  If the system breaks down, the U.S. will enter a deflationary spiral as bad or worse than the 1930's Great Depression.  If the liquidity injection works and Fed & Treasury are able to reinflate the system, it is likely that there would be some unintended consequences... such as significant inflation.  To me, there does not appear to be much middle ground.  Deflation or HYPER inflation seems to be in the offing.

I cannot tell you for sure where this winds up; there are a great many moving parts here.  My best guess is that TPTB will be successful in reinflating (from what level, well that is another moving part...), so I think you have to play both sides.  

Historically Gold & Silver have held value well even in periods of deflation, as does currency and sovereign debt.  Unfortunately, historically cash was backed by Gold the last time we had deflation... so you are on your own here...  

If you are so inclined to bet that our system has a few more breaths to take, or that my vision of reinflation comes to pass, then you should hold some equity positions.  This is not to say that TPTB attempt's to reinflate are going to work in a timely fashion with the markets deflating before the eventual inflating... sort of like the meltdown we are going through right now.

I was speaking with the Mad Scientist, and he pointed out that all of the companies that had passed on increased costs for commodities that are now not so expensive are going to be the beneficiary of the equivalent of the mother of all tax cuts, and that this should show up in their bottom lines in the next couple of quarters, PROVIDED that TPTB's efforts to unclog the credit markets are successful.

Still with me?  

It would then follow (does it ever?) that if the unclogging is successful, and considering the inflationary effects of all of the stimulus along with commodity forced price increases for commodities that don't cost as much as they used to, combined with some HORRIFIC investor sentiment... add it all up and we could have one explosive move to the upside in the world equity markets, with some sectors more than others.


TPTB fail in their efforts, and the U.S. sinks into a Japan style deflation at best, and a 1930's style deflation at worst, and you and I will be cooking spam on a stick over a dung fire.  But at least gasoline will be cheap... So we got that going for us...

Finally, there is always the possibility (probability) that Oil supplies will not be sufficient for producing REAL increases in production and output, and given the amount of stimulus, an inflationary crash could result... A person could go nuts thinking about all of this... 

My bet is that the markets are VERY over sold.  Of course, since I did not foresee the past 2 weeks collapse one might wonder what the hell do I know.  That just ain't how it works.  When it comes, you will want to be long this rally.  The question is, do you want to be long tomorrow?  And I have no idea...

Back soon,

Mentatt (at) yahoo (d0t) com

The Fly in the Ointment

The business cycle, bull then bear and then bull markets, election cycles, etc... all lend support for the prevailing view that this economic contraction will lead to a recovery at some future date.

I think we have to reconsider that eventuality.

Recessions wring the excesses out of economies and markets, sowing the seeds for the next round of economic growth.  But is that growth possible without growth in energy supplies? Total petroleum products supplied to the U.S. is down 4.4% in 2008 from 2007, with most of the decline coming from falling imports.  How can a recovery take place if this trend continues?  How sure can we be that this trend will or will not continue?  How many times have you heard this considered in the Mainstream Financial Media?  Never.  Well, then its potential cannot possibly be discounted (priced in) in the current market or economic forecasts.

Who knows?  Maybe compressed natural gas will come on strong as a transportation fuel. Maybe we will build a bunch of nuclear plants in  hurry, drastically improve the electrical grid, and develop truly viable battery technology.  Maybe we will be able to do all of this in less than a decade. Making strategic plans based on "who knows" and "maybe", like "belief" and "hope", does not engender a great deal of confidence in me.

Not that I am particularly confident of anything at the moment.  With all of the above, and the dire importance of our energy complex, the markets KILLED the energy producers and servicers, a sector I had considered a very safe haven, right along with the banks.

Go figure (and get gold).

Mentatt (at) yahoo (d0t) com

Monday, October 6, 2008


I got an email from a rather unpleasant fellow telling me what a complete idiot I am and did I notice that the passage of the Paulson Plan did NOTHING to help the markets?????

Dear Sir:

In absence of the injection plan, the Dow would have been down 2000 points today, rather than less than 400.  We have no control group, now do we?

We have not had a bone crushing crash in a while - I think this one qualifies.  Anybody who does not think we have wrung the excesses out of the market since August 28 just ain't paying attention - or has no skin in the game.


Oil is following equities, not the other way around.  If equities were paying attention to Oil, the rally would have been deafening.  Instead, the crash has done its work on equities, and Oil is following equities.  

MY BET IS, and I would caution  you not to bet unless you know how to take losses (which I seem to be pretty good at with commodities... equities? not so much...), is that we are VERY close to a bottom for Oil.  VERY, very close.  So, I bought some futures today.  I will have NO patience with this trade, because there is no guarantee that the bottom won't drop out of the equity markets - but my bet is the selling is close to over there, too.  A number of smart folks think we test 7800 on the Dow, but I doubt it.  Maybe there is 10% further to go on the down side, and then again, maybe not.

My biggest single position remains Gold, because for all of my bravado, none of us has ever seen anything like this before. I have a bunch of energy equities that are trading with VERY low multiples and VERY high dividends.  Problem is, the P/E's keep getting lower. and lower (along with the %$##!! stock prices).   Problem is, I am not a credit analyst.  I follow Oil inventories.  Looking these i would have thought the world would be freaking out.  I guess the economic contraction is happening faster than the Oil supply contraction.  


A friend of mine that actually reads my stuff - he forgot more than I ever knew about the mortgage market -  called me today to point out that if the current crisis was JUST mortgages, it would likely be over already.  The latest is fallout from the Credit Default Swap market was his opinion.  Problem is, I have no idea how to even begin wrapping my arms around that one.  

Back soon,

mentatt (at) yahoo (d0t) com



The U.S. housing debacle has brought the world to its knees.  It will be there for quite some time, in my opinion.

When the U.S. tries to get up, the oil import crisis will be there (and may already be here... the question is who is going down faster oil imports or the economy).

Holy Moly!

Mentatt (at) yahoo (d0t) com

Saturday, October 4, 2008

Just read the bill...

The pork attached to the Paulson injection plan is enough to make me puke.  Now I ALMOST wish the bill failed.  The bill was not that great to begin with. 

For months we have been talking about the housing and finance crisis.  Let us get back to the matter at hand - The American Energy Crisis.

We have truly stupid, nasty, disgusting people representing us.

Oh, well.

Mentatt (at) yahoo (d0t) com

What is a $?

Love, beauty, fairness, the US$... these are all ABSTRACTS.  They exist as concepts, not as concrete realities.

I received an email this morning from a reader quoting Mish Shedlock's excellent blog:

"There is only one thing necessary to understanding what is happening and it is this: no one at U.S. Banks, no one at the Federal Reserve and no one in politics can accept the reality that real estate assets in this country remain oversupplied, overpriced and overleveraged." (Actually, Mish was quoting someone else, but this seemed to be the jist of his argument.

I could not agree more with the quote (sort of).  If you have been reading my blog for a while I have made my position quite clear on U.S. housing values.

Here comes the rub.  We keep hearing this inflation vs deflation argument as if these 2 were natural phenomenon, like changing weather patterns.  Inflation and deflation do NOT exist in nature.  They exist in the context of an economy, and are driven by the monetary and fiscal policies of the various national governments.

In REAL terms, all of the above quote is true, though to a great deal less of an extent than was the case 2 years ago (Florida home prices are down 50% in 2 years.  They may still be overleveraged, nut the median family income can now afford the median family home.   This was not the case in 2005).  What about NOMINAL terms?  Clearly the Fed and Treasury are trying to reinflate - is there no possibility that they will be successful?

Let's say, for SILLY argument's sake, that the government passes a law that all wages are to be increased by 50% TOMORROW (stay with me, I am going somewhere).  Of course this would drive wage/price inflation up 50% but would not move the NOMINAL balance on mortgages.  This would destroy the value of savings, but would make housing relatively cheap and UNLEVERAGED very, very quickly.

The Mad Scientist mentioned that a new stimulus package, say a check for $5,000 instead of $600, would also do the trick.

As you can see it really isn't that hard to reinflate.  The question is how BLATANT the government wants to be in its efforts toward currency debasement and inflation.  If TPTB are NOT enthusiastic in their inflation mission, well, the Deflationists may well prove correct.  At the moment, my money is on the Inflationists eventual victory.  As always, I will reserve the right to change my position and bet the other way.

Now, of course the government agencies will not do anything so blatant, the impacts on our trade partners, the currency markets, etc... would be catastrophic.  But the currency debasement/wage price inflation strategy is awfully tempting for TPTB.  The debate between the inflationists and the deflationists is over how successful the government will be in their attempt to reinflate.  The Deflationsists continue to point to Japan as their model.  I think the argument is specious, at BEST, but I won't deny the probability of Deflation is some number greater than ZERO.  Japan is a very difficult comparison to the U.S. on many levels, too many to list here.

More soon.

Mentatt (at) yahoo (d0t) com

Thursday, October 2, 2008

The Frenchman, The Englishman, and the Russian

There is a politically incorrect old joke that goes like this:
A Frenchman, an Englishman, and a Russian are all to be put to death 2 days hence.

They are each granted one last request, to be granted tomorrow, the day before their execution.

The Frenchman requests one more night of passion with his mistress.

The Englishman requests one more work through the woods with his dog.

The Russian asks that his neighbor's barn and home be burnt down.

Sound familiar?
Mentatt (at) yah00 (d0t) com

Wednesday, October 1, 2008

Let's sum it up

The employment picture in Finance , Insurance, and Real Estate is going to contract HARD.  There seems to be a lot of anger out there toward the working stiffs in the financial services biz - the mortgage broker, real estate broker, insurance broker, etc... judging from the comments on my blog and the email that I get.  

Folks... I DESPISE the Stan O'Niel's and Richard Grasso's of the world as much as the next guy.  These guys, and others like them, along with their boards of directors, etc... were a disgusting bunch of unethical elitists that had NONE of the talent they claimed and were so handsomely compensated for, that absolutely stole money by the basket and took the food right out of people's mouths.  Don't worry, Oh Roman Mob... we will hang not a few of them, and spend 10's of millions of $ on legal fees and prison cells, for all the good it will do us.  What do we do with the LEGIONS of people that just went to work at these places every day?  Let them eat cake?  

Should the U.S. bring legal action against the former Wall Street execs to recover excessive compensation?  Sounds ex post facto but that would be OK with me... I think - though I am not a lawyer and I have no idea what outrageous precedent we might be establishing, considering the convoluted self righteous way in which our legal system works.  Speaking of which... remember the good old days?  When everybody could agree that LAWYERS were the universal pariah?  Ah, I long for a return to simpler days.


Now that it appears the Injection Plan is going to become law, I want to point out something that many of you who have read my stuff might find surprising:  

The Plan might not work.

Yes, I supported it.  No, it is not the best plan, or necessarily the one I would have gone with if I were a leading member of TPTB... But, I know something most of my readers (considering only the comments and emails that I get) do not - and that is how dependent our corporate payroll system is on the commercial paper market, and how that market, and hence American's paychecks, nearly came to an end last week.

We can all point to our favorite hero - Warren Buffet supports the plan (and wants a piece of it), George Soros hates it and thinks it will fail, T. Boone Pickens favors the plan, former U.S.  Treasury Secretary O'Neil says the plan is "madness".  I think they are all a bit right.  The plan IS madness, and it could work - IF the Fed and Treasury are successful in their bid to reinflate AND the Oil import crisis can be held off for a couple of years.  Still, I think that the U.S. had NOTHING to lose, and will only gain a few years for the better informed to make adjustments for the coming impacts of declining Oil inputs.

But look at it this way:  We are ALL going to die, but isn't it better to put off that eventuality for as long as possible?  

Those of you opposed to the plan might yet get your chance to say "I told you so", though I don't know what the appeal of collapsing right here and now instead of a couple years down the line has for you.  Don't be so impatient. We will get there.  Get your own house in order.


The ECB and the Fed are both going to have to cut short term rates (for all intents and purposes, the Fed already has... they just have not made it official).  This should be interesting vis a vi the various commodities.  Consider these data points:

  1. Oil & product inventories are down considerably from last year, but
  2. The Global economy is in a recession...
  3. Or is it?  It is VERY hard to have REAL Global demand decline for commodities in a world with 75 million new mouths to feed, water, clothe, and transport.
  4. The U.S. and its currency sets the price of Oil, and the U.S. is clearly in a recession.  But Oil imports into the U.S. are down 8.8% in 2008 versus 2007.  
  5. Will Oil imports into the U.S. continue to fall in 2o09 vs 2008?  If so, the U.S. recession is only just beginning (and if not, with all of the stimulus injected into the system, along with a potential Fed cut, it is hard to see how TPTB would be unsuccessful in reinflating.
  6. Still, vehicle sales are crashing, down 27% from a year ago!  What is that saying about the market's view of future energy supplies?  Is the decline all due to credit? After all, why buy a new vehicle if you don't have the fuel to run them all?
  7. Americans have no net savings.  The assets they have, real estate, stocks, and bonds, are performing poorly (to say the least). Americans will of NECESSITY have to increase their savings.  In contravention to item 5, it is very hard to avoid a significant contraction, irrespective of the stimulus mentioned, if folks save (under consume) rather than consume.
  8. Even if credit is made available in the economy we still have the budget and trade deficits, unfunded healthcare, costly wars, etc... to contend with.  
The cuts will of necessity be coordinated.  How and how much and their subsequent impact on Gold, Oil etc... is going to be interesting.  Investing and doing business in this environment is going to be beyond the word "challenging". 

Good Luck!

Mentatt (at) yahoo (d0t) com

The U.S. is not alone in the world; Main Street Avarice & Wall Street Greed

The U.S. is taking heat from its trading partners.  

The rest of the world seems to know what the House Republicans seem to have gone dim on: Your break it, you bought it.  

Americans, too, seem to have forgotten their history.  In the wake of WWI, or the Great War as it was then known, the allies, bloodthirsty for revenge, sowed the seeds of their OWN DESTRUCTION (talk about unintended consequences) by inflicting punishing reparations on Germany.  This, in part, lead the world to start numbering the World Wars, the Holocaust, which in turn pretty much led to the need and recognition of Israel, which in turn has left the Middle East as THE smoldering flash point for the beginning of WWIII.  

Main Street may want to punish Wall Street, but the rest of the world wants the U.S. to take the lead to fix the problem WE created.  And, BY THE WAY, Main Street is not guilt free in all of this.  Main Street took money it KNEW (or should have known) it could not pay back, for the dubious and uniquely American purpose of buying homes and consumer goods to appear wealthy, rather than pursuing hard work and frugality and actually achieving that outcome on the merits.  

Lastly, MOST FOLKS working on Wall Street are just well paid working stiffs (believe me on this point.  I caught the 6:31am Hudson Line into Manhattan every morning, and if I was not entertaining that evening, I caught the 6:14 home which arrived at 7:00pm.  In between, I worked in bloody cave.  Hardly "lifestyles of the rich and famous", but infinitely better than my previous occupations, and I was well paid relative to folks working in the local GM factory.  There are THOUSANDS of these working stiffs working the lights of the financial industry in order to provide for their families, and they would be hard pressed to understand why anybody should be angry with them.  Wall Street is feudal system, and the peasants should not be confused with the Noble Lords).

If you have been reading my stuff for a while you might know that I call the up coming period the "Age of Personal Responsibility".  I know it is politically politically expedient to blame "Wall Street Greed" (BTW, what is the difference between "Greedy" and "Ambitious"?  Semantics, really.  And guys, that was a rhetorical question.  Spare me the lecture.)  One never hears "Main Street Avarice", the material competitiveness that engulfed the nation over the past several decades - McMansions for a family of four, Cadillac Escapades complete with $4000 spinning rims, etc... Did I miss something here? And was it  REALLY Ronald Reagan's fault?  Or did the American people not engorge themselves on a feast of debt at a table that they themselves had set?  Yes, Wall Street served the meal - and Main Street ordered eagerly from the menu. 

And it WAS fun while it lasted.

A new era is here, thankfully, and "January 20, 2009 will be the end of an error" (that was on a bumper sticker. I loved it).  

Good Luck!

Mentatt (at) yahoo (d0t) com