Mr. Market & Expensive Lessons

If I were going to identify one mistake I've been making in recent time, it has been a greater reliance on options when I am trying to get long or short (usually long).  As someone who subscribes to the notion that what is inevitable is not always imminent, in using options you can end up being right and still losing everything you invested.  While we have not quite reached that point (zeroed out), I would say that my decision to use options to gain some leverage on gold mining stocks was a mistake.  Twice over.  First, I was greedy, then, my timing was off.

As we discussed last year, I allowed an account transfer to get in the way of capturing doubles and triples on my mining options.  I was of the belief that the time was finally right.  It wasn't.  After a big move that I expected, everything reverted back, and actually now has gone lower than my original basis.  I basically have until next January for the rest of the investing universe to catch on to gold again or else my calls will expire worthless.  I'm skeptical about my chances.  There is a euphoria in the markets again that is absurd, but a reality for the time being.  People just don't realize they need gold yet.

In any event, I think I might take some losses and re-invest or just sit with the cash.  As Billy Joel once sang, I've got bills to pay and children who need clothes.  For the time being, money put there might be better spent.

He lays out the problem well...

An interview today on CNBC with George Soros:

Soros: ...when you have unemployed resources, putting those resources to work the is really the first objective, and -- and you (have) to re-establish growth for shrinking the debt. And so I think the policy basically pioneered by Bernanke is actually the right policy.

Bartiromo: You're not worried about the fact that the Federal Reserve has expanded its balance sheet so much, the ECB expanding its balance sheet so much? Is there a down side risk there?

Soros: There is a down side risk because once the economy gets going, then interest rates are going to take a big leap because this is a delicate two-phase maneuver where first you throw more money at the economy and as the economy picks up, you have to take that money out.

So, tell me, do you have confidence that the Fed can do it? Have they successfully done it before?

Ahead of the Trend

In looking for new investment ideas, there is a group of investment professionals who I like to pay attention to.  They often can be the genesis for ideas that I end up taking to the next level.

Well, with that in mind, today Harris Kupperman posted about a new long position for his fund in the Russian Ruble.  Which means that two of the guys who I think are pretty smart have started saddling up to Russia within the past few months.  Namely, there was also a story back in September about how Jim Rogers had taken an advisory role with an ag fund run by a Russian bank.  He then was on TV in the months following announcing that he was no longer a bear on Russia.  Interesting.

Am I going to do anything about it?  Not yet.  But, it certainly gives me something else to study up on.

Internet Maroons, Take 2. And...action!

I have heard many arguments over time for why gold is a bad investment – but today I stumbled across this gem from Noah Smith, world class economic bloviator, who takes the recent cake:

“If it's obvious that central bank money-printing will drive up the value of gold, why isn't that fact already incorporated into gold prices?”

A few things to say.

First, for anyone who has been paying attention for the past 10 or 20 years, shouldn’t it be fairly obvious that the markets’ character as a discounting mechanism has just up and vanished. It’s why we see bubble after bubble. But, more than that, market sentiment is greatly important. As Fleckenstein observes, the predominant fear has been deflation, which I don’t think is a permanent feature. So, continuing to own some gold now allows me to get in front of and to profit from that eventual shift. Professor Blowhard – err, Smith – is welcome to disagree and take the other side of that trade. But, his position (reliant on the idea of efficient markets) on its face is just foolish and flies in the face of what is actually going on in financial markets.

One other point. He observes that the S&P has outperformed gold in any 30-,40- or 50-year period. What a bizarre thing to crow about. For starters, until 40 years ago, there was a dollar-gold peg, which meant that gold and cash tracked. So, should we be shocked that stocks did better? But, after 1971, depending on whether you’re focused on the Dow or S&P, stocks are up 1,400% to 1,500%. Gold, you ask? Nearly 5,000%, even after the year-plus of recent consolidation.

My takeaway: there continues to be plenty of reasons to believe that gold is far from a mainstream investment choice and fully priced. When that day finally arrives, I will try to be keen to it and disembark accordingly.

Update: So, looks like I might be a bit of an internet maroon today also.  I forgot to bake in dividends in comparing gold to the indices.  If someone held the S&P since 1971 and reinvested every dividend, they would be above 5,000% return.  Nevertheless, the larger point still stands -- the commentary about efficient markets is absurd.

More Internet Maroons

A slow day around the office, so I checked in at the various blogs that I follow.  Somehow I got pulled to a recent video of Mike Norman lambasting the Kyle Bass thesis on Japan.

For those who don't remember Norman, he's the guy who was laughing at Peter Schiff during an interview in 2006 as Schiff warned of a housing bubble.  Even though that video subsequently went viral, and he was shown to be something of a dope, he still has people paying attention to him.  I guess some people never learn.

In any event, his main criticism of Bass' idea (and Norman has a way of being a real condescending gasbag in making the case) is that any country which controls its own currency, and holds all its debt in that currency, can never be in danger of default.  His position is not new ground here on our little blog, but it did get me thinking about it again and why I would never invest money with this clown.

In a literal sense, he is right.  But there are obviously unintended consequences.  Even if the bonds can always be paid off because the central bank can print up endless currency units, the value of those currency units are likely to suffer.  So, imagine you are an island nation with few natural resources, that recently shut down most of its nuclear plants because of a tsunami, what is the impact of a depreciating currency unit as you try to import the stuff you need?

Also, he tangentially makes the point that somehow Japan has been suffering through decades of deflation because of tremendous efficiencies and productivity.  Really?  They keep having to import more and more as the savings rate goes down and down and the debt-to-GDP level goes up and up, all in the context of troubling demographic trends.  Ouchie.

Exhibit 1

Last week, we touched on the projected "surplus" in California, largely based on greater revenues expected to follow from the approval of Prop 30.  Well, if Phil Mickelson is any indicator, those anticipated revenues are probably a lofty and unrealistic goal.  And then where are we?

Amazing

From today's Casey Daily Dispatch:

"The Macondo prospect, located off the coast of Louisiana in the Gulf of Mexico, was home to the Deepwater Horizon drilling rig explosion. The oil reservoir that Macondo was supposed to tap held about 50 million barrels of recoverable oil. The world burns through 84 million barrels of oil every single day. That means the oil extracted from Macondo would have supplied global oil demand for less than 15 hours. All that effort to produce just 15 hours' worth of oil!"

The Surplus in La La Land

Last week, Governor Jerry Brown announced expectations of a $891 million budget surplus in California for the coming fiscal year.  It is premised, of course, on higher tax receipts after the referendum that was passed back in November.  I am planning to do my own research on the budget to assess how realistic it is, but let me offer at least one potential point of contention up front.

As we know, the state of California has a simply humongous public pension system.  To the extent that there is ever a shortfall, the onus falls on the taxpayers to cover it.  Currently, CalPERS assumes a 7.25% annual return.  That target (which only reflects the most recent reduction in the discount rate) has not been hit in a great long while.  Partly because of terrible management, partly because we live in a ZIRP world.  At this point, the accumulated shortfall is projected to be anywhere from $162 billion to almost $900 billion.

So, when you hear about budget surpluses, keep in mind that it is relying on some pretty optimistic expectations for a pension program that has been a terrible underperformer.

Quick Rant to Close the Week

-Nothing specific happened today, but I was thinking about it so I’ll share. The progression has been something like this… Short sellers are evil and unpatriotic, so let’s try and ban them. But, wait, even on the long side, we’re going to implement taxes and fees because some of you guys aren’t holding your positions for long enough.

Can only imagine what bright idea will pop up next. Whatever it is, Doug Casey has it right. Governments treat their citizens like milk cows – eventually it will be beef cows.

-Rebel that I am, I opened a couple of small speculative options positions this week.  All with March expirations.  The GLD $175 and $180 calls, and some AAU $5 calls (whose chart I think is really compelling).  The other that I am considering is NEM, maybe some calls for later this spring in the $50 strike price range.

Battle of the Villians

I happened to have the TV on this morning tuned to CNBC and caught an interview with David Boies. He is representing Hank Greenberg in his lawsuit against the U.S. government regarding its takeover of AIG in 2008. As usual, Boies was a captivating speaker and with those of his interviewers (mostly Becky Quick) who tried to argue from a moralistic standpoint (rather than a legal one) against his client, he did a rather effective job of quickly exposing the flaws in their position.

Anyway, having just finished up Financing Failure, this case has become a lot more interesting to me. It sounds like the primary defense that the government will offer revolves around the notion of systemic risk and how the financial system would have imploded but for the government’s extraordinary acts. McKinley’s book points out over and over how the guys at the Fed and Treasury talked about how the world would end without the intervention, but never really laid out the case beyond rhetoric. It was almost as if, by stipulation, that assumption was correct. Well, through this case, maybe the government will really have to lay out that argument once and for all.

From a rooting standpoint, I think it would be rather satisfying to see the government lose. But, in the bigger scheme, there are no heroes here. AIG should have gone bankrupt.

More Funny Money Shenanigans

For those not paying attention, one idea gathering steam lately (in econ blogosphere land) is to have the Treasury mint a $1 trillion platinum coin in order to evade the pending debt ceiling showdown.

The basics go something like this: under the law, the Treasury is able to mint commemorative platinum coins without any restrictions as to face value. Thus, those of a more donkey-like persuasion see a potential loophole – get the Treasury to issue a coin with face value of $1 trillion, deposit it with the Fed, and the Bernank can gin up some new dollars and no additional debt needs to be issued. Thereby, Obama and team can avoid Republican efforts at re-visiting the debt ceiling episode from a couple years back.

In particular, Paul Krugman has really gotten on-board with the idea (here, here, here and here), most recently linking to an article where esteemed Harvard law professor Laurence Tribe weighs in on the absolute legality of the plan.

But, it seems that Professor Tribe is glossing over some relevant details and recent case law – J.P. Koning does a great job of summarizing. Specifically, a Las Vegas man was convicted in 2009 of tax evasion for paying his employees in gold coins at the face value amount ($50) of the one-ounce American Eagles. The court said that it’s the intrinsic/market value that counts. In addition, under Section 16.2 of the Federal Reserve Act, the Fed is only supposed to collateralize notes where the underlying securities are sufficient in amount. Put differently, it would be a blatant disregard of the rules to pretend that a $1,500 platinum coin (at market value) is sufficient collateral to issue $1 trillion in freshly-printed moolahs. But, as the past few years have demonstrated, and the book Financing Failure highlighted so well, those rules are often glossed over for political expediency. In any event, there is a compelling argument for why the platinum coin loophole is not copacetic.

As to my personal take – the whole debt ceiling issue is all about theatrics anyway. The current brand of Republican is as much austerian as Krugman is neocon. In other words, much like the “fiscal cliff”, don’t expect anything substantive to come out of this dance. No meaningful grand bargains, so why even bother with the charade in the first place.

There is Nothing Conclusive in Economics

I came across an interesting article by Steve Horowitz (and Michael J. McPhillips) that fleshes out the idea of Robert Higgs that World War II did not cure the economy from the Great Depression.  Instead, the war had to end first before better standards of living returned.  The argument is that all standard aggregate measures of an economy are pretty misleading during the war because of conscription, price controls, wage controls, and shortages in the accessibility of goods and services that people normally desire, all a result of the creation for destruction process. Beyond the obvious interest that I have in the role of World War II as remedy to what ailed the economy way back when, the article also brought to mind something else that I read.

Paul Krugman has a recent post on his blog about Latvia that includes the following statement: “Even in Keynesian models, a small open economy can, in the long run, restore full employment through deflation and internal devaluation; the point, however, is that it involves many years of suffering — in the long run we are all dead.”

So, to bring it all together, WW2 is often portrayed as the compelling case for Keynesian theory as the solution to depression. But, if the point is to avoid prolonged agony, and as Horowitz and co-author formulate quite well that, for as long as it lasted, the Keynesian “solution” was also quite unpleasant, then shouldn’t there be a major re-think by the Keynesian overlords?

300

I kicked off the new year by finishing up Financing Failure by Vern McKinley (2011). The author runs through all the financial bailouts in the U.S. over the past century, taking a negative view and arguing that history really does repeat itself.

The common theme is that politicians cannot let anything bad happen on their watch. Accordingly, in times of panic and without a full understanding of the facts, they implement huge bailouts, rationalized with fear mongering and by suggestions of terrible knock-on effects if nothing is done. To that point, McKinley spends a great deal of time parsing through and serving up the words of the relevant players (i.e., Bernanke, Paulson, Geithner, Treasury, Fed, FDIC) and establishes that their blustering words of imminent peril are never backed up with compelling data. Add to that, there is an inconsistency in why someone is bailed out – the explanation for why Lehman failed but it was important to support AIG and Bear Stearns is still hard to understand. Sure, a false distinction is made between liquidity weakness and capital weakness, but it is not very convincing. All of which adds to the uncertainty that proves to be the real problem.

McKinley also examines the idea of moral hazard – how the bailouts and protections instituted in the aftermath of a panic actually encourage more reckless behavior going forward. Whether it is higher levels of deposit insurance or letting an insolvent institution live on, the risk-takers see little incentive to dial back their behavior. As a case study of how bailouts do not have the intended effect, the author follows the story of Continental Illinois Bank and Trust Company. It was bailed out in the ‘30s, again in the ‘80s, and was eventually subsumed by Bank of America, which everyone knows was bailed out in the 2000s.

The upshot is that bankruptcy is the logical conclusion for a poorly-run company. Thus, according to McKinley, the government does have a role – to wind down these failing institutions. Sadly, that obligation is often ignored. Instead, they create new regulators (surprise, surprise, usually it’s the same folks who missed the original crisis, just with a new title), new laws, and new bureaucracies. The answer is always more government. And the outcome is always another crisis down the road.

So, to quote the author, quoting Ecclesiastes: “What has will be again, what has been done will be done again; there is nothing new under the sun”

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This post marks number 300 for the blog. Thanks to all who have stuck around.