It's Only Natural

When it feels like the world is on your shoulders
And all of the madmen has got you going crazy
It's time to get out, step out into the street
Where all of the action is right there at your feet
--Debarge

I've felt a bit naked after taking off all commodity positions over the past month. Of course, their continued ramp higher prolly has something to do with that.

To regain some commodity exposure, I've taken a starter position in natural gas. Being long natty gas has been a house of pain over the past yr or so. Prices have been crushed, as near term supply is swamping demand as new liquid-based sources have been initiated.


But gas is currently selling under $4 per million BTUs (multi-yr lows), and I'm not sure I've heard more bearish tones to this material since I began following it a few yrs back. Technically speaking, it appears that the nasty downtrend is giving way to some basing action.

As such, I like the risk reward here, and hope to use price to my advantage to build a more significant position.

position in natural gas

Paying Up

Doyle Lonnegan: "You're boss is quite a card player, Mr Kelly. How does he do it?"
Johnny Hooker: "He cheats."
--The Sting

People viewed Friday's payroll numbers with optimism as the bottom line job losses number was less than expected. The data collection and analysis process behind this series is so tortured that it is mostly meaningless.

According to the BLS release, employment fell by 'only' 345,000 (over half a million was expected). However, the infamous 'birth/death' model added a hypothetical 200k+ jobs into that estimate.

The official unemployment rate upticked to 9.4%, a high water mark thus far for this recession. My sense is that this number is headed significantly higher despite all attempts to massage it lower.

During the Depressionary 30s the unemployement rate hovered at 20% for much of the decade. The official unemployment rate number today is not determined in the same way we did it then. For example, we do not include 'discouraged workers' (those who are not actively seeking employment today altho they are qualified.

Were we to add all those omissions back into the series today, folks would be surprised how much worse the data would look. Of course, this is the reason why we don't do it.

Before this period is over, we may see 'old way' unemployment at or above 20%. We're closer now than you might think.

Short Spectrum

"You've got to know the rules before you can break 'em. Otherwise it's no fun."
--Sonny Crockett (Miami Vice)

There's increasing banter about perma-bears and that 'nearly everyone is bearish.' Could be, but whenever I hear someone utter 'Everyone is ___' I think two words: confirmation bias.

Better to think in terms of a distribution of sentiment and the spectrum of behavior across it. After all, each time a share of stock changes hands, by definition, one party is bullish and the other side is bearish. The trick is to understand changes in the distribution of bulls and bears.

Along those lines I wanted to note this chart showing NASDAQ short interest at multi-year lows. Other indices indicate a similar decline in short side operations. The contrarian in me wants to say that this is bearish (general sentiment is usually wrong, less fuel for squeezage, etc.).

Then again, note that short interest rose with higher market prices and then declined with the general market break, suggesting short interest as a coincident rather than contrarian indicator. Add to that anecdotal evidence that many 'famous' bears such as Jim Rogers and Fleck are currently not short, and it makes you wonder just what what all of this suggests in terms of sentiment and future market direction.

For me, this means staying on the sidelines and waiting for clearer opportunities on either side--long or short.

no positions

The Future is Now

Hey kids, plug into the faithless
Maybe they're blinded
But Bennie makes them ageless
--Elton John

While speaking to the House Budget Committee today, Fed Chair Bernanke declared that, "The Federal Reserve will not monetize the debt.

In permitting such a statement to pass uncontested, perhaps the HBC does not comprehend the definition of debt monetization.

Or perhaps it's hard to recognize an activity when it's already being done on a massive scale.

Time Tunnel

"Don't worry. As long as you hit that wire with the connecting hook at precisely 88mph the instant the lightning strikes the tower, everything will be fine."
--Dr Emmett Brown (Back to the Future)

Wanted to post the cartoon from the 1934 Chicago Tribune cartoon appearing in Pep's missive for future reference.


I do marvel at the cycle of history. Also strengthens my resolve to study more Thirties this summer.

Dragon Tales

Diane Court: "Nobody thinks it will work, do they?"
Lloyd Dobler: "No. You've just described every great success story."
--Say Anything

Minyanville professor Kevin Depew offers another data point that supports the aforementioned hypothesis of 'near term deflation followed by significant inflation.'

Pep appears to sense that the influence of the deflationary phase may begin to lose its steam by Q4 this year. While certainly plausible, I wonder whether it'll take more time to kill of debt to the point where we're ready for a truly secular shift in things. The Japan situation comes to mind.

Of course, I may just be feeding Morton's Demon.

Broken Arrow

Come out of things unsaid
Shoot an apple off my head
And a trouble that can't be named
A tiger's waiting to be tamed
--Coldplay

As a postscript to the previous couple of missives, John Hussman nicely lays out the current macro issues that markets face. Note also that although he expects serious inflation over time, his proposed time frame is 5-10 years from now. Meanwhile, he suspects more downside related to the debt-financed 'expansion,' which seems to me deflationary.

Nearer term deflation followed by prolonged major inflation. That's a forecast that fits my views-in-progress pretty well right now.

Dr John's 'Erase the arrows' story also well reflects the current state of the economic academy.

Shakedown Cruise

It was thirty days around the horn
The captain says it's a thirty-five more
The moon looks mean and the crew ain't staying
There's gonna be some blood
Is what they're all saying
--Jay Ferguson

Purty pattern in the major indices lends further credence to the notion that this move higher could persist. The move today creased thru the 200 day moving average. Resistance resides above at SPX 1000 and 1150.

Meanwhile, fear of missing is on the rise.

Is my nonsensical vision of a rally thru summer still intact? Yep. As of yet, have I added any incremental exposure to express this view? Nope, but I might given the right setup.

But make no mistake, I believe this move, however long in duration, will ultimately end in tears.

no position

Rate Debate

You're begging me to go
You're making me stay
Why do you hurt me so bad?
--Pat Benatar

Why do bond interest rates go higher? The short answer is that creditors are less willing to take risk, and therefore demand more premium in order to lend. But what factors lead to creditor risk aversion?

One factor is future inflation expectations. If lenders perceive potential for increasing prices (e.g., devalued currency) in the future, then they will demand a higher coupon to compensate for the reduced purchasing power of the principal and interest returned to them down the road.

Another factor is general capacity to lend. Creditors may lack investment capital due to previous practices (e.g., excessive lending or borrowing against their book). If so, then lenders will raise the price of further lending to compensate for their balance sheet risk.

A third factor is creditworthiness of the borrower. Creditors will demand more premium if borrowers carry more risk of default. Think junk bonds.

When rates head higher, as they have for govies over the past week, the knee jerk explanation that pundits commonly assign to the phenomenon commonly relates to the first factor noted above. Higher rates are typically explained as heightened inflation expectations.

But the latter two factors, those less cited by the pundits, are tied to a deflationary environment. And in a world drowning in debt, these two factors seem to merit more attention.

Don't automatically connect higher interest rates to potential for more inflation.

Dukes of Hazard

We can dance if we want to
We can leave your friends behind
'Cause your friends don't dance and if they don't dance
Well they're no friends of mine
--Men Without Hats

In previous missives we made the case for a period of optimism, where bureaucrats, pundits, and investors would perceive that massive market interventions are working and that the worst is over. We appear to be in this period now, as bureaucrats chat things up and investors are jumping back into the pool--many with both hands and feet.

Echoing Mr P, my view is that any appearance of stability is merely an illusion, one that has been facilitated by throwing tens of trillion$ at a system that is effectively broken. More debt and spending can't solve a debt and spending problem. Current interventions merely serve to make the system more unstable down the road.

Instability favors extreme outcomes when potential energy turns kinetic. Two extreme scenarios seem plausible. One is a high inflation situation, where attitudes reverse towards greater risk seeking. Borrowing and debt expand--perhaps at even greater rates than those witnessed during the past few decades. Prices, particularly those linked to materials, scream higher. As commodity prices have just completed their biggest monthly jump in more than 30 years, market participants are casting a strong vote for this scenario.

The other plausible scenario is that after a stint of 'reflation,' a secular deflationary trend re-establishes itself. Credit markets, already up to their eyeballs in US debt, shut down for domestic borrowers. Borrowers, moreover, lose their appetite for risk, given the already extended state of their balance sheets. Prices of risky assets resume their decline.

I've waffled in my probability assignments toward these scenarios. For many years, I was entrenched in the deflation camp, which served my in pretty good stead. But after last year's collapse and the massive interventions brought on by past and current administrations, chances of the high inflation situation ratcheted higher in my eyes.

Now, however, I'm once again leaning towards the deflationary scene. There's still too much debt out there (not enough has been destroyed yet), and my sense is that borrowers and lenders are losing their appetite for risk. Most 'cash' out there is not free cash, but rather borrowed and linked to a liability. Rather than plowing this cash back into risky assets, there's a good argument to be made that people will use this cash to pay down debt. And because of the massive quantity of debt out there, this situation could last a long time.

As such, I've tilted my portfolio back towards the deflationary possibility. After shedding most of my commodity exposure after this recent run, I'm holding more cash than I have in a long time. Although I recently borrowed to buy a house, my plan is to chunk my mortgage down at an accelerated pace.

Should the inflation scenario win out, I'm holding a few dividend paying stocks as well as some gold as a hedge.

While financial markets can certainly run a while, my growing sense is that risk is high and getting higher.

position in gold