A Contrarian Take On Oil

Heretical or just contrarian?

Energy. Everyone wants it; not everyone has it. Once it’s produced (as electricity, let’s say) it’s tough to store, tough to transmit, and tough to price. For the past few months, turmoil in the Middle East has driven the price of crude oil (WTI), the most commonly cited energy commodity, up around 30%. Remember when $90 oil was a threat to the recovery? Anyway, I have been recommending an overweight to energy, but quite honestly, except for a modest allocation to energy, my focus was on the domestic market through nuclear and coal companies. I can’t complain as they’ve done very well over the past 6 months. It did however, lead me to review my underlying thesis on energy. Will my anticipated slowdown (negative for energy) overpower the continued geopolitical turmoil (positive for energy)? Will China’s slowdown (negative for energy)play a larger role than the possible hoarding behavior by governments afraid of supply disruptions (positive for energy)? And the questions go on.

Here’s the short of it. I still like energy. I think the risk of supply disruptions is high, and while I anticipate China, as the marginal buyer of commodities, to face a significant slowdown, I believe the geopolitical situation is worse than most are pricing in, all coupled with a continued devaluation of most world fiat currencies. That being said, look  at the chart below (from BarChart.com). Do you notice any outlier?

Of course natural gas is an outlier. There’s plenty of it – no one is discussing peak natural gas – AND, importantly, there a huge domestic supply. It’s underperformed the rest of the complex by 40-60+% over the last 12 months! For a contrarian like me, it definitely looks interesting.

Now, natural gas happens to be a very difficult market to trade. Even professionals get caught up in spreads, roll issues, extreme moves with little liquidity; for example, that’s what brought down Amaranth for those old enough to remember yesteryear. Also, the active contracts are for the front months, which wouldn’t actually provide me with the long-term exposure I might want. So instead, I need to focus on the companies themselves. For those who have the ability to do the due diligence on individual firms, companies like Calpine or Southwest Energy might be interesting (I don’t have positions in either). For those interested in gaining more broad exposure, check out FCG. I’ve mentioned it in the past and it’s held up well, especially given the recent price history of natural gas. Again, I don’t have any exposure to it at the time of writing, but am looking at it for now. One thing I do know, though, is stay away from UNG. Retail investors love this fund for some reason, but it is fundamentally flawed and I wouldn’t be surprised if we see it close at some point soon if natural gas heads any lower. It might pop on some big moves in the underlying, but the direction is clear. This is not a contrarian play.

So there you have it . . . While everyone is selling natural gas, to me it’s beginning to look like a good place to be. No positions yet, but it’s the type of play I like.

Relevant ETFs/stocks: SWN, CPN, FCG, USO, BNO, XLE, CORN, UNG

Don’t say you weren’t warned

Here’s an idea: the real trigger for the correction won’t be the Middle East. As Libya, Bahrain, and maybe soon Saudi Arabia take center stage, pundits and analysts the world over are focused on oil, commodities, inflation, and Wisconsin unions. But the Middle East wasn’t the marginal buyer. Overall, Middle East countries tend to be poor and uneducated, repressed and un-democratic. They are not, however, the marginal price-makers for copper, Caterpillar, or US treasuries. For that, we have to look to Asia.

Here’s something that is being completely ignored by the mainstream media: there is a bankrun happening in Korea. The eighth bank closed earlier today, and while that seems like something that happens over a weekend in the US, it’s a big enough deal to motivate the financial services chairman to deposit around $18,000 in a checking account as a way to calm markets down. He probably already regrets his decision.

So what is the warning? The warning is don’t let the pizazz of the Middle East distract you from the main attraction: Asia. China is facing increasing social unrest. It is only one of many un-democratic regimes, with a poor, uneducated class that is facing increasing food prices. When Asia faces its brick wall, look for industrial commodities to fall sharply as the region begins to export a global slowdown faster than the US’s anemic growth can balance.

Relevant ETFs: JJC, FXI, EWY, AAXJ, GMF, FXP

Quick note

As the markets hover down around 1-1.5%, I just want to point out the the financials are not providing any strength, nor are the recent performance leaders such as NFLX. In fact, it’s these same companies that are leading us down…

In the meantime, anyone who got into the commodity rally late (against my advice), and bought into CORN or similar ETF is going to face major headwinds as spec positions get routed:

Relevant ETF/stock: NFLX, XLF, CORN

Feeling like an outsider

Everyone is talking about inflation. All the time. Wheat. Everywhere I turn. Every chart that is burnished. Cotton. Newsletters. Bloggers. Traders. Inflation. Copper. So it makes me feel like an outsider when I don’t really think inflation is the problem we need to worry about. Or rather, it’s not a simple case of rising prices and depreciating fiat currencies.

Let me point out a few discrepancies I’ve noticed for the inflation camp. Prices of commodities are rising, which will be passed on to the end consumer. For me, that’s a maybe. I think there is a lot of room for substituting down and for limiting purchases. We see it in company reports – Dean Foods doesn’t sell the brand name milk as people switch to the generic. That’s trading down. I think there’s also room for stopping certain purchases much quicker than analysts anticipate.This leads me to worry about margin compression much more than a pick-up in inflation.

On a related note, we don’t see employment and wages going up. Where do inflation mongers think that the funds for increased prices will come from? I don’t see wage inflation picking up in the near future.

Housing is down, and it’s not coming back yet. Without housing (and I’m talking about global real estate in general) where will this mythical demand for such commodities as copper come from? China’s property bubble is bursting, the US housing market is going down, Japan’s demographics will soon lead it to destroy housing, etc. Other than fear and speculation, what’s driving the underlying demand? Silver and gold going up is not a sign of inflation. On the contrary, they are signs of fear and rightfully so. Fear can be fear of inflation, but it can also be fear of instability and deflation. Their price movements are certainly not a support for the inflation camp.

What makes my position even more difficult is the fact that I agree with a lot of the underlying issues these same inflation campers are mentioning. Printing is dangerous for the dollar. Housing has not been a store of wealth. Producer prices are rising. etc. On top of it, I agree with SOME of the implications. I am negative on long term treasuries and credit in general. I like gold and the precious metals complex. I like the energy complex. And more.  However, I diverge on some fundamental issues: I don’t think like retail and don’t believe the retailers will be able to pass along price hikes. I think a Chinese slowdown is already here and will ripple through the commodities space. I anticipate major margin compression and am very negative on equities. I think gold and silver are harbingers of fear that will cause people to hoard cash as well. I don’t anticipate wage inflation.

All of that was a long-winded way of saying I haven’t found a camp where I feel totally comfortable.

Relevant ETFs: JJA, DBA, COW, MOO, TBT, TLT, EEM, SPY, TIP

Treasuries – Can we finally agree the bond bull is over?

Treasuries continue to fall. 10 year yield is sitting at 3.6% and it doesn’t look like they’re heading back to 2.6% in the near future. Maybe we’ll have a bounce, but the bond bull is over – it has been for a while.

In an environment with increasing yield, can equities continue to rally? The answer is easy: it depends.

If yields are rising due to inflationary pressures, than equities can rise as corporations gain pricing power, are able to pass on rising costs to the end consumer, and earnings rise in line. However, if yields rise due to a debt deflation cycle, where companies have limited pricing power, but debt gets revalued lower, then equities will be hurt. My fear for a while has been that we are entering the latter. Yesterday, I increased our short exposure to equities, and maintain a large cash position. I have been early for a long while on the end of the equity surge, but have not taken the other side actively until this week. I think we’ll start with an 8-10% correction, which investors will think is an opportunity to buy-the-dip, but any bounce will be short-lived.

In the meantime, fears of inflation coming from commodity speculators will prove ephemeral, as debt deflation leaves companies with less pricing power, and will just serve to squeeze margins. I still like the precious metals and energy, but I’m not putting funds to work in the ag space at these levels.

Relevant ETFs: TLT, TBT, SH, SDS, SPY, IWM, RWM, TIPS

Yields

The drama in yields is fascinating to watch, and at least in my own small way participate. If you haven’t, check out Bill Gross’s continuing missive on why to short long dated treasuries (http://tiny.cc/hxv6o) – the basic gist is that treasuries offer a low return/high risk investment and you’d be better off putting your money elsewhere. In the meantime, 2-30 spreads are blowing out as the yield curve is steeper than it has been in memory and the only think keeping rates low by historical standards is the continuing propping up of prices by the Fed, which is not the largest holder of treasuries.

In the meantime, I’m happy to be short treasuries, but I can’t say that it will be a real winner in the short term. While inflationary fears are running wild, with sugar, cotton, wheat, and all of agriculture hitting new highs, I am not confident that it’s not a speculative move that will end with new entrants getting burned. I’m not jumping in. I’m still maintaining my exposure to precious metals, and I still like energy, but the rest of the commodity space seems too risky for my investing discipline. If and when they come crashing, treasuries might have a last hurrah, which is why I’m not increasing my short treasuries position here. Just maintaining.

In the meantime, for a good source on viewing the changes in the yield curve, you can start here: http://stockcharts.com/freecharts/yieldcurve.html.

Relevant ETFs: TBT, TLT, AGG, DBA, CORN, SGG, JJA

A new year, but not much has changed…

Sure, it will take a couple of weeks to get used to the “idea” of 2011, if not the reality. The main changes with any new year, in terms of investments, are structural. Tax losses have been taken, performance numbers have been set, bonuses have been calculated, etc. It is also a time of prediction, which is always a fun game.

For me, though, it’s also a time for reflecting. I spent most of 2010 getting increasingly concerned about valuation and inter-market relationships, most important of those is the impact that currency relationships will impact other asset classes. As I turned the annual leaf, I thought I would reexamine that posture, from both a numbers perspective, but also a bigger, more conceptual perspective.

It ain’t pretty. From a valuation perspective, the equity markets are as overvalued now as they were at multiple other peak, except 2000:

• The relationship of the S&P 500 to a regression trendline (more)
• The cyclical P/E ratio using the trailing 10-year earnings as the divisor (more)
• The Q Ratio – the total price of the market divided by its replacement cost (more)

“To facilitate comparisons, I’ve adjusted the Q Ratio and P/E10 to their arithmetic mean, which I represent as zero. Thus the percentages on the vertical axis show the over/undervaluation as a percent above mean value, which I’m using as a surrogate for fair value,” said Doug.

According to this methodology, the Index is overvalued by 63%, 43% or 38%, depending on which of the three metrics you choose.

Source: dshort.com

These fundamental indicators are really bad timing mechanisms, because each of them could continue extending, but they all point to the same thing: equities are in a danger-zone.

What about treasuries? When Bill Gross, who in 2008 supported a trillion dollar deficit, now writes:

• American politicians and citizens alike have no clear vision of the costs of a seemingly perpetual trillion-dollar annual deficit.
• Policy stimulus is focused on maintaining current consumption as opposed to making the United States more competitive in the global marketplace.
• Dollar depreciation will sap the purchasing power of U.S. consumers, as well as the global valuation of dollar denominated assets.

Read the full article here.

Back to Basics: Six Questions to Consider Before Investing

GMO just published a new paper titled “Back to Basics: Six Questions to Consider Before Investing” with the idea that there are six questions to ask before investing in a particular asset class, although the framework can be used on a smaller level as well.

Here are the six questions:

Would investors rationally buy this asset if they did not believe it would give returns above cash?

If investors would buy the asset in the absence of a risk premium, we cannot be confident that there should be one long term.

Where do the returns from this asset come from, and who funds them?

We need to understand the sources of return to properly analyze historical return data and we need to understand what entities are funding the return to give insight into their motivations.

Why would the funder of returns for this asset be willing to offer a return greater than cash in the long run?

If there is no good reason for the entities funding the returns of an asset to be willing to fund a return above cash, the sustainability of a risk premium is questionable.

In trying to understand the analysis, we have an additional set of three questions to consider.

Have the historical returns been consistent with the risk premium we expected?

If we thought there should be a risk premium and there wasn’t or vice versa, perhaps we have missed something important about the asset class.

Have the sources of the returns been consistent with the returns achieved?

If we cannot fully explain where the returns have come from in an asset, we have defi nitely missed an important factor.

Has something important changed to make us doubt the relevance of the historical returns?

The existence of a historical risk premium for an asset and an understanding of where it came from are nice, but if something important has changed about those buying the asset, those funding the returns of the asset, or the characteristics of the asset itself, history may not be all that relevant.

Good framework to start the conversation. The author, Ben Inker, then goes on to look at equities, bonds, commodities, PE, VC, and volatility. For me, the discussion of commodities was particularly interesting as Inker outlines the cost of the roll, the challenge of finding sellers in a rising market, etc.

For the full article, click here.

10 o’clock check up

We’re constantly trying out new ways to update our subscribers, so we’ll start with a few charts to review:

The USD was due for a bounce and it’s lucky we’re getting one. Why? Because holders of US assets, specifically bonds have been taking it on the chin. Even though bonds have stayed strong, they’ve been losing on the currency translations. How long would they be willing to pour money into our treasuries? Probably not long. The Fed recognizes this and is stepping in as the purchaser of last resort. Fine for US investors, not great for the bulk of our treasury holders who need the USD to strengthen or we’ll see massive dumping. Its the world vs. the Fed in trying to determine USD strength and I’m not sure any of the outcomes are good.

Commodities are hot and they’re all over the news, and I live my wheat as much as the next guy, but these things look stretched. How much of this move is fundamental, demand-driven and how much is a reflection of a weak USD? Not sure, but Dennis Gartman postulated that the recent corn report may have been the result of some government shenanigans to drive up prices:

The farming communities in the Midwest are going to be resurgent, and the equipment manufacturers, the fertiliser sales organisations, the grain elevators and perhaps most of all the small local banks will benefit manifest and continually. After a decade of weakness, strength returns to the farming Midwest.

Read about it in the FT.com here.

I wouldn’t be surprised, but regardless, I’m wary of taking new positions in the space.

And a last couple of notes:

• Pfizer buys King Pharma (KG) for $3.6 billion cash. Nice.
• Fed minutes come out today at 2PM.
• Thailand tried to cool their currency by imposing a bond tax.

Inflation stories starting to surface

Deflation has been all the rage the past few month as bond prices continue to astound bringing yields down, and analysts like David Rosenberg at Gluskin Scheff turn out to have been right. And, I admit, I too have been in the deflation camp, arguing that a global slowdown, and a Chinese slowdown especially, will cap any upward price pressures. I’m still in that camp, but not as adamant as I used to be. There are a few major trends on the horizon that are starting to tilt me to the other camp.

The first is structural. Globally, governments are all in stimulative mode, trying to outdo each other on the easing fronts. Japan is the classic story of the government continually being thwarted with higher yen, but if there’s one thing a government can do effectively is devalue the currency, so I expect the government to eventually win. But Japan is not alone. Ireland is issuing debt to itself, in an apparent twist on the ponzi scheme – in the Irish version, they’re actually pyramid-ing themselves, without bringing in new investors. Hmmm. Probably not going to work out well for them. The US too is in easing mode, which will eventually mean yields will rise. So, while I’m not in the inflation scare camp yet, global easing continues to make me fear fiat currencies.

Then, there are the stories, apparently unrelated, but sounding incredibly similar. Coffee prices up by a third in the past few months as reported by the WSJ. How about Russia banning exports of wheat, sending the prices higher? What about gold hitting new highs? Check out the corn ETF:

True, energy hasn’t skyrocketed, but it also hasn’t broken down in the face of global slowdown. How about POT getting Chinese interest? Or the increase in rare earth materials? For now, a lot of these prices moves are supply disruptions and not being driven by demand, but could they lead to an increase in consumer prices and a flight to “needs” in the near future? Very possibly and it’s something to keep an eye on. For now, economic slowdown and consumer retrenchment are the orders of the day, as is debt deflation (coming soon) on the corporate and sovereign sides, and depressed equity valuations. But at least on a relative basis, if not on an absolute basis, the recent moves in the above mentioned markets might give us insight into where to invest.

From hoof to mouth, or why derivatives don’t kill people…

Despite the best efforts of the Obama administration to draw a clear line between Wall Street and Main Street, business owners, farmers, and everyday citizens recognize that there are overlaps that make the distinction irrelevant.

GILTNER, Neb.—Farmer Jim Kreutz uses derivatives to soften the blow should the price of feed corn drop before harvest. His brother-in-law, feedlot owner Jon Reeson, turns to them to hedge the price of his steer. The local farmers’ co-op uses derivatives to finance fixed-price diesel for truckers who carry cattle to slaughter. And the packing plant employs derivatives to stabilize costs from natural gas to foreign currencies.

Far from Wall Street, President Barack Obama’s financial regulatory overhaul, which may pass Congress as early as Thursday, will leave tracks across the wide-open landscape of American industry.

Designed to fix problems that helped cause the financial crisis, the bill will touch storefront check cashiers, city governments, small manufacturers, home buyers and credit bureaus, attesting to the sweeping nature of the legislation, the broadest revamp of finance rules since the 1930s.

Here in Nebraska farm country, those in the business of bringing beef from hoof to mouth are anxious, specifically about the bill’s provisions that tighten rules governing derivatives. Some worry the coming curbs will make it riskier and pricier to do business. Others hope the changes bring competition that will redound to their benefit.

“Out here we like to cuss the large banking institutions because of the mortgage mess, but we also know that without them some of these markets don’t work,” says Mike Hoelscher, energy program manager for AgWest Commodities LLC, a Holdrege, Neb., brokerage that provides derivatives services to the farming industry.

(Emphasis added. For the full article, click here.)

What does it mean for financial regulation when farmers are scared? While derivative regulation might be necessary, I don’t know that corn and wheat hedging is where we need to focus. Overall, the commodity complex represents the first financial instruments in history and futures and forwards have been utilized in some way since ancient times. This is not the area that caused the collapse, nor is it the derivative area that represents the systematic risk our politicians are trying thwart. In the meantime, the true culprits, namely, financial futures, CDS, swap agreements, etc. which dwarf the size of any of commodity futures markets will continue to be less regulated. It’s a sad state of affairs.

If you trade commodities, ETF’s, futures, or anything: Read This!

This might be the most important article on the structure of trading in physical, options, futures markets that I’ve ever read. For those involved in these markets, it’s a must read. I can’t excerpt it – because IT IS ALL IMPORTANT! It is pretty technical, but it highlights the pitfalls of trading, issues with financial vs. physical exposure, etc.

To go to the article, click here.

Connect the dots 6-10-09: Part I

We’re going to start the weekend with our weekly market monitors.

What do we have here? This year is full of stress, but looking at the broad averages, the S&P is down slightly. What a ride!? So what do we see when we look deeper?…

Commodities (ex natural gas), emerging markets, and tech certainly pop out. Interestingly, I’m not sure they are telling the same story. Tech tends to be low debt companies. Earlier today Goldman even upgraded Dell and hinted that investors should revisit tech. Companies would be pulling back on some tech investing in the current environment, except…Except for productivity enhancing tech or cost saving tech. Remember, a lot of companies still have cash on their balance sheet from a year of decreased transactions. Stock buy-backs and dividends aren’t where the companies want to spend their cash because re-issuing shares down the line seems questionable at this stage. Large acquisitions are out of the question. So, what’s left?

Commodity related industries tend to be capital intensive and they’re certainly levered to any growth. Yet, in an environment like this, growth assumptions are low or negative for most of the world, so I doubt that the argument holds. Instead, maybe the answer lies in the expectation that inventories need to be rebuilt. Over the past 18 months, despite the consumer slowdown, production levels decreased even faster and inventories have shrunk to the point where any pickup could send producers scrambling. Who’s facing the shortest inventory? Not surprisingly, our old auto industry is front and center. Once again, the US auto manufacturers are going to get caught flat-footed. They’ll finally face a little bit of demand, but not enough capacity will be on line and commodity prices will have gotten away from them.

Anyway, TBT continues to grind lower and any “investors” left in it, should see some of our previous postings on levered ETF’s. It will slowly grind away at your returns, even if the direction is correct. (I do not own TBT nor do I own it in client accounts.) I’ll speak more about the bonds complex next week, but I have to admit that everyone and their brother is telling me about bonds with equity like returns, but sitting at the top of the capital structure. I think the “easy money” of buying solid bonds at 60 to 70 cents on the dollar is gone. Now you’re in for a grind with the smartest guys in the room. Maybe that 8-9% yield on a BBB credit is OK given that Treasuries are paying 3%, but when Treasuries go to 6% (not a far stretch) these will go down much farther and much faster. Do you really think the yield will go down? So you’re clipping a nice coupon, which is well and good as long as they pay, but if California can default so can that from AA company. And if you think the economy will improve, better to get the leverage in the equity. It’s probably at decade lows (using a representative BBB company).

Barron’s has mentioned it. The Big Picture has mentioned it. So you should at least be aware of it. Last year, Rogoff and Reinhart wrote an analysis of financial crises and the impacts on different asset classes: Aftermath. The basic conclusion: in the aftermath of a financial crisis, asset classes show higher correlation and there are very few places to park. Equities and real estate and bonds and whatever all face severe headwinds. All of that was to say, watch out for the 8% bonds. It might just be a trap.

Connect The Dots 06-05-09

This issue of CTD was written with significant input from Thatsabet and others. All charts and tables are from Bloomberg.

Equities:            The week started off with the much anticipated official bankruptcy of GM. A clear case of sell the rumor, buy the news, the market shrugged off the immediate implications and started higher. Yes, GM and C are going to be replaced in the Dow Industrials by TRV and CSCO. The academic literature would suggest that GM and C will now go on to outperform TRV and CSCO, but this is a recap of the week. For those interested, check out New Evidence on Stock Price Effects Associated with Charges in the S&P 500 Index, by Anthony W. Lynch and Richard R. Mendenhall (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1298790) and countless others.

The main story this week in the equity markets was the 2-10 spread in bonds (see our bonds summary). The moves in bonds and FX are signaling some big mispricings (adjustments?). For starters, check out this chart:

This is the SPX and EUR/JPY. EUR/JPY is the ultimate carry pair and has been a pretty good barometer of risk in the global markets. While the rise of EUR/USD is at politically sensitive levels after the recent rise, the JPY is also at critical levels. Thatsabet believes that should the 94.5 level be violated, it might lead to an unwind in the EURJPY which in turn could cause an unwind and lead to pressure on global equities.

Thatsabet also points out that many people like Japanese equities here for a long-term investment. The Japanese are 20 years ahead of us in their path to clear the imbalances of bubbles. The chart below shows the correlation of the US 10-year yield and the NKY. Depending on the cause of the rise in US yields, the JPY could get stronger as Japanese repatriate their currency and drive their local markets higher. Full disclosure, I have been increasing exposure in client accounts to small cap Japanese equities for the past few months for fundamental, valuation reasons, but this confirms some of our initial hypotheses. The Japanese small cap stocks represent some of the best value opportunities globally at this juncture. We have been buying JOF and other yen exposure.

This week is full of charts because the pictures really capture a thousand words. So three more charts:

First, SPXFX – This is the SPX from the March lows until now valued in different currencies. In USD terms, we have experienced the biggest rally since the 1930’s, yet in AUD terms, the market is only up roughly 5%. The currency markets are not confirming the equity strength and are calling into question the US’s ability to fund its future liabilities.

Second, XLFSPX – This is what the banks (XLF) have done relative to the SPX since 07. This spread is still trending lower until we see that .15 is decisively taken out. More time is needed in order to determine the validity of this rally. Thatsabet compared buying XLF here to buying XLK (technology) in 2001.

Lastly, let’s head to the emerging markets. From 2003 to 2007, with reflation and decoupling a virtual given, the emerging markets continued to outperform relative to the SPX. Then, the world stopped. EEM fell off a cliff (at a rate significantly faster than the SPX – remember this is the ratio of EEM:SPX). Just as violently, the ratio shot right back up. Thatsabet defines himself as a cautious decoupler. I personally don’t believe the decoupling trade or mentality. I believe that the interconnected nature of the currency, bond, and equity markets along with labor mobility, decrease in international trade barriers, etc. means that decoupling is not the driver of the trade. It’s the reason we look at NKY and TNX and examine the interconnectedness of markets now more than ever. Decoupling will be a topic we discuss at greater length in the next few weeks.

Bonds:              LQDTLT – This is what being long LQD (Corporate Debt) and short Treasuries has produced:                           

Since the break in 4Q07, corporate debt has been in a bear mkt. What is now occurring is either an “exhale” and corporate debt is cheap (concur) or the markets are realizing that the US government has taken over the leverage from the private citizen and will have to issue more debt to fund the fiscal gaps. Thatsabet goes so far as to think that over the next several years, US GOVT yields will be higher than corporate debt and emerging market debt. I tend to disagree in the near to medium term, at least.

Looking at US 10-year yields, we are approaching 3.9% and may test the 4% levels. What are the implications for home refinancings, which have already slowed? What about asset allocation models for big institutions? At what point will they be comfortable with the yield and move from stocks to bonds? At what point will the higher yields be an impediment to any imminent growth? Just as critical will be the shape of the yield curve. A flat or inverted yield curve often signals a coming recession (it also makes it extremely difficult for banks to make money). We have been seeing a steepening yield curve with the 2-10 spread rising to levels not seen since the 70’s or longer. A steep yield curve implies that investors do not want to own long dated fixed income securities, often because of fear of inflation. Julian Robertson (article posted) is playing this for size. Pretty amazing seeing that it is already historically wide. He thinks yields are headed to 7% and possibly as high as 18%.

Currencies:       The sentiment this week has been one of mixed messages. Dollar negative news continues, with gold rallying, yet no clear winner on the other side. The Euro continues to face its own headwinds, despite some recent strengths, and no viable alternative to the USD. The GBP is going through its own issues with Gordon’s government facing mounting pressures. Safe havens are becoming scarce.

Commodities:   Check out the CRB in USD and EUR since Mid Feb (prior to rally). Broad index is up only 10% vs 25% in USD. The affects from USD weakness is being felt more by the US and USD fixed currencies. Either the USD catches a bid and fast or the world better quickly adjust to ever higher CRB prices.

This is gold in USD AUD EUR JPY since the start of the 4Q08 selloff. Gold is positive in every FX to the tune of 20% except JPY which has been bid due to the carry unwind. I expect the XAUEUR to be the next blast off as the EURUSD is bound to correct. With everyone focused on DXY and the 78-80 level one needs to understand that the index is 57% EUR. The EU members will be finding it difficult to export with such a strong FX. A correction is in the cards.

On the energy front, oil is hitting the $70 mark and being used as evidence of a recovery. This is a chart of Mexico’s Oil Production. Their production seems to have peaked in 2003 and has been steadily declining since. Can they ramp up production or is the peak theory crowd correct? If the peak oil crowd is correct, what will happen to energy prices when demand really does rebound?

Economy:         Jobs. Jobs. Jobs. US Initial Jobless Claims: We are currently at the highest level since 1979 (give or take). With today’s figures out, the unemployment rate is at 9.4%. That’s almost 1 in 10 people unemployed AND that’s with the numbers calculated very differently than 30 years ago. At the same time, Steve Ballmer of Microsoft threatened to move jobs abroad if the current administration continues to move towards making it prohibitively expensive to hire workers in the US. With labor movement into the US reversing as opportunities in emerging markets relative to the US increase, where will the growth come from? From where will we get the young people needed to balance our aging population. Note this chart was from yesterday and doesn’t include this mornings numbers.

And to top it off, our usual performance tables…first, are the major markets we’re following, and second are the main sectors’ performances relative to the S&P500.