Sipping On Gin

I’m back in the swing of my usual day, after spending most of the weekend in western New York, attending a funeral service.

Weddings in the summer…funerals in the winter…that about sums up my years.

Now, for whatever reason, oil markets are cascading down, bowing to reason. I don’t know if this will be the lead up to the big plunge, or if it’s just another head fake before more pain. But what I do know is that oil prices right now are completely unrealistic. Oil should be in the $80’s, at most.

The Iran embargo is only better for oil prices. There’s more than enough oil for the major economies, but we fight over every barrel produced. The embargo is a de facto division of the planet’s oil; Iran and some others go to China; the rest of the Middle East is Europe’s; and China and Europe in turn butt out of American oil.

This simple restructuring could allow prices to plummet, as you can bet supply will not be affected by this act. However, demand will be controlled, artificially, by non-compete agreements. We’re making a buyer’s market here, but you are all too busy crying in a corner to see the big picture.

Finally, Europe remains a train wreck. The issue at hand is not a Greek default, although it’s proven very funny watching the talking heads go from dismissing a Greek default to declaring it imminent but dismissing any real consequences.

You lot are nuts; the big looming issue is that Europe, in net, needs to either default on a trillion euros this year, or print them, because private markets are not in the least interested in investing in countries with 100%+ GDP and swelling incompetent windbags for leadership.

If (When) Europe continues to break down, the repercussion is going to be U.S. exports that crumble. That will crush U.S. growth as U.S. multinational conglomerates, plus half of emerging markets, are going to see earnings get slaughtered from exchange rate dependent “one-time” line items…indefinitely.

Hey, do not concern yourself with Europe’s problems. If you want to escape that old sawmill, all you’ve got to do is throw money into China! China is flashy and new, with all the latest and greatest things to mesmerize you. So says Jim Rogers and other noted China bulls.

The fact that Chinese manufacturing continues to shrink at a rapid pace should not dissuade you in the slightest from throwing your life savings into their equity markets; which are of course guaranteed and well respected legal property, as dictated by the Chinese government. Chinese officials carry themselves with the utmost dignity and respect for their fellow man, and would never do anything that might be viewed as overstepping their bounds.

Never you mind that of China’s $1.2 trillion of exports, 20% of those sales go to the EU (before factoring in the UK), or that exports to the U.S. and the EU were down 12.5% and 19% last year, respectively. These are simply facts, and as everyone knows, China is impervious to facts.

In the golden land of China, Chinese officials do not just falsify reports and create phony statistics. The Party of Mao is so thoroughly in command of China that when unemployment is unsatisfactory and the government feels the need to print better numbers, a corresponding number Chinese people immediately find employment to satisfy those publications. Lesser nations have to spend months organizing labor and resources and managing production targets to achieve this end. But China is simply that much better.

Thus, Chinese officials always speak the truth. Unemployment in China persists because China does not wish to make the rest of the world feel inferior. It is their gift to us; but one day China will simply make it law that everyone in China has a job and is content, and then we will all be like “oh damn, I’m envious.”

Actually, China is so good, you should do more than simply buy their companies, with their crowning achievements of superior Eastern processes and zero error reporting. You should take the next step, and tie up 50% or more of your net worth into highly illiquid investments, like Chinese farmland.

Chinese people absolutely love it when foreigners buy up their ancestral homeland in huge swaths, especially when the Chinese overlords dictate that some of them should be unemployed and suffering, as a sort of fasting. When this happens, it never tempts them to encroach upon the absolute legal rights of the non-Chinese men and women who have seized their properties. As is well known, Chinese communists have incredible respect for property rights, especially of non-citizens.

But if this is not enough for you (and I know you may hardly be containing your excitement), then you can take it all one step further; move to China.

Chinese culture is one of the greatest in the world. From refreshing labor in FOXCONN facilities, to a wonderful 300 mph commute; from morning jogs through stimulating rain in Beijing, to a delicious cup of fetus soup on a chilly night; and all the greatest outlets for you to voice your non-native opinions – a permanent relocation to China is a successful choice for any aspiring investor.

If your Chinese farmland already has a homestead on it, then you are all set. However, should you find yourself in need of housing, it is your good fortune that China has many vacant locations for you to buy – literally entire cities of units, actually. This is because demand for Chinese housing in immense, but China foresaw this decades ago, and hence has managed to stay perfectly ahead of the curve.

The wonderful thing about Chinese housing is the poorly kept secret that no one ever loses money on it. In fact, to accentuate this point, China briefly made it illegal to sell your house for anything less…purely a joke, naturally.

What is certain is that, whether you are committed to a 100% Chinese investment lifestyle, or are just looking to grab yourself some rice paddies or tech companies, China will always be a good investment regardless of what the rest of the planet is doing, because they are totally isolated and in complete control of every aspect of their own nation.

The 9th floor office is being blanketed in swirling snow currents this morning, a scene that I have put my back turned to.

You don’t realize it yet, but things are changing very dramatically. The Baltic Dry Index continues to crumple while shit rockets galore dot the skyline. Expectations are far too high, with this morning’s factory number out of the Philadelphia Fed coming in significantly below expectations. And the only cheerful news is that 0bama has managed to erase great breadths of the population from record, on his quest to seal a second term.

And what is your part to play in all of this? Well you are a rabbit, of course. One of many…

You are one of many rabbits set loose in a minefield so that those of us who know better can pass through behind you unharmed.

It’s almost funny, watching the white marks streaking in zigzags across the field. Some of the quicker and more dexterous of you have managed to make it to the other side already. And you’re looking back with a smug complacency, as if to say “don’t you wish you were me.”

No, actually, I don’t. Because you are expendable cannon fodder. And soon enough, the poor jackasses who are trying to follow in your footsteps will set off a most horrible display of gore, as landmines detonate in near sequential timing, rocking the field and dotting it in red-white painted pocks, while instilling panic and the fear of God in the immediate survivors, who will then flee to danger, setting off the next wave of concussions, and the next…

As you run around “masterfully playing oil” and “nailing that BAC trade” the big money is busy hedging themselves down as tightly as they can muster, using you to cover their open liability, closing their trade imbalances, and holding cash.

I want to show you a couple of things I’m looking at.

Firstly, the Baltic Dry Index versus the price of oil:

(Image from investmenttools.com)

A bit of background; the BDI has been plunging as represented by the cost people are willing to pay globally to ship goods to other parts of the world. This coincides with a drop in global demand as represented by worldwide manufacturing.

I’m hearing the voices trying to dismiss the BDI as a poor indicator; the BDI like basically every other type transaction, determines price on the margin, which is to say very small net imbalances relative to the gross numbers coincide with disproportionately large price swings (a small shortage causes prices to skyrocket and a small amount of excess can collapse them). Okay, well then you’ll have to dismiss more or less every other indicator also, because that’s how trade works.

I could agree that the BDI is off mark if it weren’t that it is coinciding with other ominous signs. Firstly, as I’ve already displayed with the image above, is that oil and fuel prices are increasing. If energy prices were increasing because of demand, then wouldn’t the BDI be increasing alongside them? Secondly, look at the collapse of rail traffic that occurred last month. The third is the strengthening U.S. dollar, and the weakening euro, which really together powerful sway global trade.

So why is the BDI dropping like this? I admit it could be that the prices of basic materials have been dropping, and so raw material producers are demanding a subsequent decrease in shipping margins. This is the most sanguine outcome. Dollar strength, in and of itself, is causing lower good prices forcing concession on the part of shippers, but that strength is only redirecting trade flows and net transactions are actually stable.

(Image from Yahoo)

However, because of the magnitude which input costs like fuel affect the room for prices to move, I am inclined to believe that a bigger reason is that, globally, demand for goods is slowing down.

Now more directly to our situation here in the U.S.: our GDP is probably about $15 trillion, give or take. Meanwhile, thanks to a cheaper dollar up until mid-2011, our exports were booming and our imports were stabilized, resulting in some steady reductions of our trade deficit…until recently. Our exports according to World Bank numbers, as of 2010, were 13% of GDP; so how much directly would exports have to collapse, by themselves, to utterly abolish any hopes of the U.S. growing?

The answer is about 20%. That reduction would more than suffice to send U.S. growth screaming to zero.

But in actuality, the amount needed is less. Reduction in exports also causes U.S. unemployment which will directly harm U.S. domestic spending. How badly does it skew? Well it’s impossible to lock down for sure, but understanding how consumer participation in networking works, if our trade deficit starts to blow out because of exports collapsing, then the U.S. economy could see a multiple of those base numbers; maybe 2:1, maybe much more. So really a reduction of U.S. exports by 7-10% would definitely be more than sufficient to crush U.S. growth.

And the worst part is, the Fed would be nearly powerless to fix such a problem in the current environment.

It’s tempting to fall on the old crutch; well Bernanke will just devalue the dollar improving U.S. exports.

Will he now?

But at $100 a barrel, oil is already straining the margins of business profits considerable, slowing the flow of currency, and any act of easing would cause oil prices to go higher, not lower. What would that do to the economy? It is unfortunate, but at some point, dollar devaluation is incapable of being absorbed by the population, and reality materializes anyway…plus additional consequences. Do not overlook the fate of the nations of history, who dared to believe that printing money was some catchall. I couldn’t tell you if this next round of expected printing would actually fail; all I can say for sure is that, where we are now, printing is a wild card with uncertain ends.

If basic demand is really inverse to price, then Bernanke cannot increase exports without creating a counter effect on domestic consumption and production. And besides, it’s not like devaluing the monetary supply to increase exports is some great secret of the 21st century. Every other country on Earth could use the extra cash flow, so why do you think a Bernanke print job would not be simultaneously met by all the emerging markets of the world?

Now, the latest report from November shows net exports shrinking about 1%. Another 6 months of that and I’d bet all U.S. growth is gone. However, the potential for a shakedown of exports is much worse than that. Remember, the greatest growing export of the U.S. is actually fuel.

How much fuel do you think Europe is going to need, if they keep shrinking? Ditto for emerging markets, given the precarious state of their biggest buyer?

Actually, the decline of our exports could accelerate based on the developments in Europe. And if fuel costs begin to fall dramatically in fashion, then our exports could be hit by a third force of momentum.

So, based on the latest trade reports, I’d guess we’re about one quarter of the business cycle away before hope that the U.S. somehow mystically leaves the rest of the planet behind is extinguished in a plume of disappointment. And the worst part is I don’t think Europe or other markets are going to greatly benefit from our stronger currency because the disappointment from the U.S. letdown will very likely temper purchases of imports. Not to mention that their problems are so extensive, continued austerity and reservation will overpower whatever slight benefit they gain in trade pricing.

In conclusion, dollar strength is persisting because of investors looking for safe havens, a weak economy in foreign trade partners, and a broad drop in most basic materials – energy notwithstanding. This, and the plunging demand abroad plus softening demand at home, is causing the Baltic Dry Index to plummet; which is very likely a good indicator of the direction which economies and markets are headed right now, rather than some sort of false signal. I expect the dollar to continue to gain against other currencies going forward, further decrease in demand globally, a discontinuation for the expectation of growth in the U.S. and most other nations, and eventually a run lower in markets for both equities and commodities as people finally acknowledge these developments and adjust to them.

The International Monetary Fund, despite being a global organization, has pittance for a budget. It was designed to help save dick, third world dictators from the fallout of their poor leadership, by pumping low quality loans into their banking systems.

As you can imagine, it doesn’t take much money to completely wash a place like Zimbabwe in currency worth more than the cumulative of 10 years of their gross GDP.

My point is this; the latest EU salvation announcement – that the IMF is going to bail out the world’s largest combined economy – is dumb.

But first things first; where have we heard this storyline before? Wasn’t leveraging a meager reserve balance into a miracle homerun supposed to be the faculty of the EFSF? So this announcement, foremost, is an indirect acknowledgement that the EFSF plan is effectively dead. Why else repackage literally the exact same idea and try to feed it to the public like it’s shiny and new?

Second, where is the IMF going to get that kind of money? Last I checked, their budget sucks. If they were to have any hope of actually raising the kind of money they’re talking about, they definitely need a bigger set of deposits. Who’s giving them those? Germany isn’t giving money directly to Greece; they’re not giving money to an institution that’s going to give money directly to Greece either. The U.S. sure as hell isn’t going to associate with this; you want to see conservatives start setting Executive Branch Office buildings on fire? Try to force the U.S. to accept that kind of liability for Europe’s little welfare mess.

And then they need to actually get anyone to loan to them. Who’s going to do it? The entire EU together couldn’t garner enough interest to raise 600 billion euros. The IMF only expands liable counterparties to include the U.S. (great budget to absorb shock there…) and some emerging economies – the same emerging economies that have heretofore refrained from loaning money to Europe!

Get over it, guys. Nobody is going to invest money into saving Europe just so Europe can live comfortably for 2-4 more years before this issue rears back up again. There is too great an expectation (totally justified) that Europe will screw over anyone who puts their faith in them, in order to buy some more time. Look at the labor movements that are welling up in places like France and Greece, and you will understand why no sane man or women will be investing in any of these hairbrained schemes to “magically leverage away” all of Europe’s problems.

The rest of the planet would love to have the same things happen to their debt. Everybody can come up with much better uses for their own resources than to throw it into that bottomless pit.

The ride into the 9th floor was dark and murky, with black clouds pouring rain on my homeland. The office was dark when I entered it; the sudden flood of light that covered all but the corners of the room contrasted with the sink of illumination behind my window panes.

I swallowed down a quick breakfast of whatever morning breads I could lay my hand on. My other hand, whichever that was (for I was acting too inattentively to recall) raising my morning cup of coffee and cream to my lips in between bites. And over this meal of mine, my eyes have been busy scanning every news source I can come across.

This is absolutely comical; the market rally being laid at Standard & Poors feet. You could scarcely write such irony. I can’t tell if the market is rallying because it legitimately thinks it has a reason? Is it a coincidence, perhaps? Or are people remembering the U.S. downgrade outcome and piling in?

It doesn’t matter, because I’m getting the same rise out of it all the same. Really, even though I hate the rally and persist in betting against it (counting to 4 months now since my losses started; 7 months is more realistic, to be honest), I almost appreciate this rally. Standard & Poors pours their souls out there, taking a huge risk to face off against the irresponsible forces that really created them, and BAM! they immediately get socked in the face…not by governments, but by the very market they think they’re looking out for.

Can you imagine what S&P employees must be thinking this morning? Holy hell, I wish I could see their faces!

This is the most worthwhile money I’ve ever lost. You can’t buy entertainment like this at a movie. And besides, I’ll make it back soon enough. If only for today, I’d say losses well spent. I hope this ends with the EU banishing all credit rating agencies, thinking they’re being clever. At that moment, if the market were to utterly collapse, stiffing the EU just after totally destroying S&P’s credibility, then I’d have to sacrifice a hecatomb in its honor.

As funny as this is, don’t lose sight of the big picture. The “massive” rally in the euro is pushing it above 1.27. That’s a far cry from the 1.3 mark it was trading at as early as two weeks ago. The euro’s run to 1.28 has already broken down. And the commodity rally so far is weak sauce. In world news, every indication is that Europe is still going into a steep recession, and I don’t believe a damn word that comes out of China.

Until further observation, I’ve got no reason to believe that this is anything other than a gyration on the path of a lower euro, higher dollar, and presumably lower equity and commodity prices.