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Forex Blog - When Bubbles CollideWhen Bubbles Collide
June 6, 2008When Bubbles CollideUnemployment Jumps to 5.5%, OnIts Way to 6%What the Tax Numbers ShowWhat's Up With Oil?America on a DietMontreal, a New Book, and aWedding
I remember in the summer of 2006 I would face my blank computer
screen on a Friday and wonder, what I could write about? The media was
all Goldilocks, all the time. Today, there is such a target-rich
environment. I could probably write three letters a week, there is so
much happening that is worthy of our attention. The problem today is
trying to decide what not to write about, which means I get
emails from readers wondering why I don't mention their areas of
particular interest. But at eight pages, I just have to stop. You need
Today, we have to look at the unemployment numbers, and
the connection between the credit crisis and the rise in oil of about
$16 dollars a barrel in just two days! If there is still room, the
dollar is certainly being pushed and pulled by central bankers, who are
also worried about inflation. And I doubt we will have room to cover
what is a very important rise in inflation in Asia. It is all
connected. (And you HAVE to look at the picture of my daughter and
associate Tiffani at the end of the letter. Too much fun!)
first, a quick note. I will be in Las Vegas July 10-12 for the annual
Freedom Fest Conference, where I will speak several times, and the
line-up of speakers is as strong as for any conference I have ever been
to: Denish D'Souza will debate Christopher Hitchens; and Steve Forbes,
Ron Paul, Stephen Moore (Wall Street Journal), Charles Murray,
George Gilder, John Goodman, and about 100 other speakers, each
impressive in their own right, will be there, as will 1,500
freedom-loving attendees. You can go to http://www.freedomfest.com/promo.htm
and click on the list of speakers to register. Mark Skousen is the
driving force behind the conference, and he does it right. I hope to
see you there.
Unemployment Jumps to 5.5%, On Its Way to 6%
headline number said the US lost 49,000 jobs in May, somewhat fewer
than expected. The details were much uglier. It is no surprise that
construction saw losses of 34,000, but "goods production" also saw a
drop of 57,000 and manufacturing was down 26,000. What was up? Health
care (34,000), bars and restaurants (11,000), and government added
17,000 (though, as Phillippa Dunne and Doug Henwood of The Liscio Report noted, the gain was all from local governments, as federal and state governments shed jobs).
with all the large losses and few gains, how did we show a loss of only
49,000 jobs? As long-time readers will guess, it is our old friend, the
birth/death model, which is the estimate of new jobs created by new and
small businesses, which are not covered in the survey. Contrary to some
opinions, it is not a conspiracy by a government agency to "cook the
books" in an attempt to show a number better than it really is. (If it
was, they are doing a really bad job!) It is simply a moving-average
projection of the past few years. Like any trend-following system, it
will be wrong (sometimes badly) at the inflection points of the change
in the trend.
Thus, the Bush administration was right to be upset
when the birth/death model significantly understated the growth in jobs
during the recovery from the last recession, as Democrats talked about
the "jobless recovery." Subsequent revisions showed that in fact there
were a lot of jobs being created.
And now? As the economy rolls
through a recession, the system is overstating the number of jobs
created. It is just a function of the model. The BLS is very open with
the numbers it uses, if you care to dig into them. In October the BLS
will announce new benchmarks and apply them in March 2009, although
they will only be applied through March 2008. The number of lost jobs
through last March will be revised significantly upward, just about the
time the recovery is underway. And also in time to help modestly
understate the jobs being created in the recovery. As my friend Dennis
Gartman likes to say, anybody who trades on the employment numbers
deserves the spanking they get.
For the record, "March was
revised down by 7,000, and April by 8,000. We've now had four
consecutive months of downward first revisions, and also four
consecutive downward second revisions - unusual strings that support
the picture of a weakening employment trend." (The Liscio Report)
the birth/death model? This month it added in an estimated 217,000 new
jobs. But looking into the details, the model suggested that 42,000
construction jobs were added. The survey showed lost jobs in
construction, but the birth/death model added more construction jobs
than were lost. Given the current economic climate, that is highly
improbable. Ditto for the 77,000 in leisure and hospitality. Do we
really think 9,000 jobs were added in financial services or another
9,000 in small manufacturing start-ups?
The reality is that we
probably saw a decrease in jobs of at least 100,000. The market was
upset with 40,000. What will it do when the monthly number prints
100,000 later this year? And it likely will. The Federal Reserve
projects that unemployment will rise to 6%. That means there are a lot
more jobs to be lost. And that is if unemployment stops at 6%, which
would be a very mild recession indeed.
There are two unemployment
surveys. One is for businesses, called the establishment survey, and
for whatever reason that is the one most people pay attention to. When
they do the household survey, they found that the number of employed
people fell by 617,000 last month, spiking the unemployment rate to
5.5%. Some on CNBC said it was just teenage unemployment showing up in
the numbers, but that is not true. Teens, according to Phillippa,
accounted for just 0.2% of the rise. Adult unemployment rose to 4.8%
and accounted for 0.3% of the rise. (By the way, technically, for the
three people with no social life actually watching the scorecards, the
household survey dropped 250,000 jobs; but after you adjust for factors
in the establishment survey and seasonally adjust, you get 617,000.)
of the best indicators of the direction of employment is temporary
employment. If the workload is shrinking, the first thing you do is lay
off your temporary help, or simply do not hire them. Normally,
unemployment is a lagging indicator, but temporary help is at least a
coincident if not a leading indicator. Temporary employment is down
5.7% year over year and is showing continued monthly deterioration with
each passing month since last October. That does not bode well either
for future employment or consumer spending. We will watch to see when
temporary help begins to rebound, to give us a hint that a recovery may
be in our future.
What the Tax Numbers Show
Philippa Dunne & Doug Henwood write The Liscio Report.
They focus on interpreting the employment numbers and doing in-depth
research on tax collections at the state level, plus a lot of
interesting "inside" information not typically known by the public.
When you see an analyst talking about tax collections at the state
level, there is a high likelihood that the source of the number is
actually the work of Dunne and Henwood. I find their letter very
useful, as I get analysis very quickly after the report comes out, and
you always get "the rest of the story" not revealed in the press
releases and the media. (www.theliscioreport.com) If I ran a trading desk I would want their reports on my desk.
called Phillippa about a report they sent out this week. Basically,
sales tax and income tax collections at the state level are either down
or flat. You can do all the surveys and polls you like, but one of the
rules of life is that no one pays a penny more in taxes than they have
to. The flip side of that premise is that sales tax collections are a
VERY good barometer of economic activity.
Phillippa was kind
enough to send me a chart to share with my readers. The have a
diffusion index which tracks how well states are doing in meeting their
projections for tax receipts. This does not show the level of receipts,
as a state could be "positive" in this index if it projects lower
receipts and meets that target. In general, states have been lowering
their projected income.
As it turns out, this index is a fairly
consistent indicator of the direction of retail sales, as the graph
below will attest. The green bar line is their sales tax diffusion
index, and the red bars are retail sales growth. Their index has
dropped precipitously in the last few quarters, leading retail sales
down. And it suggests there is more pain in retail sales to come.
wait, didn't we read yesterday that retail sales were up? "Wal-Mart
sales, for stores open at least one year, increased 3.9%; Costco US
showed a 7% US gain and a 15% foreign gain. BJ's Wholesale Club sales
surged 13.4% on gasoline and food sales. BJ reports gasoline sales
jumped 6.6% and perishable food sales surged 11% but general
merchandise was flat!!!" (The Bill King Report)
that did not have food and gas to boost their sales showed considerable
weakness. GAP was off 14%, JCPenney down 4%, and Limited Brands down
6%. Even the high-end stores like Saks (-9%) were down, and Nordstrom
projects that June will be down 22%. Given the sales tax numbers, I
would not be buying the retail stocks on the dips. There is an old
saying about trying to catch a falling knife.
Auto sales have
fallen precipitously on the lack of demand for trucks, which were the
most profitable item for car manufacturers. Is it any wonder they are
cutting back and closing plants?
Wages declined by 0.2 in April
in nominal terms, and forget about it in real, after-inflation numbers.
David Rosenberg of Merrill Lynch notes that the 0.2% decline in real
spending on durables and semi-durables was the 6th decline in a row,
which has never happened in the 49 years that such data has been
tracked. He notes there has never been a time when consumer spending on
durables (like cars and appliances) and semi-durables (like clothing)
have contracted for two quarters when the economy has not been in a
But there are other reasons for the slowdown
in consumer spending. Since 2001, the average income of the bottom 90%
of wage earners dropped by 0.9%, from $32,371 to $32,080 in 2006, in
constant 2006 (inflation-adjusted) dollars. The further down the income
scale, the more pressure on the consumer. (source: Center for American
The top 10% have seen their incomes rise from $221,000
to $254,000, a rise of 15%. Side bet: we will see the average income of
the top 10% come down in 2008 and 2009.
From Goldman Sachs: "We
estimate that the US government ran a budget deficit of $160 billion in
May, about $92bn wider than in May 2007. Most of this reflects tax
rebates (about $50bn) and calendar effects (about $27bn). The remaining
$15bn is true deterioration, reflecting reduced tax revenue growth as
the economy stagnates. In particular, withholding of income and payroll
taxes was flat and corporate payments (usually tiny in May) fell."
short, wherever you look, tax receipts are down. That means income and
sales are down. There is no spin that trumps tax receipts. And
Phillippa told me that her sources at the various states she surveys
are not optimistic about a real recovery in the latter half of the year.
would not want to own any stock whose earnings are tied to the US
consumer. Between rising input prices and falling sales, earnings are
going to be squeezed. Today's almost 400-point drop in the Dow is just
a precursor to the direction of the market, until consumer spending
starts to recover. This time, there will not be large mortgage equity
withdrawals to bail out the economy. We will see a slow growth/no
growth Muddle Through Economy for at least another 12 months.
What's Up With Oil?
price of a barrel of oil was up $16 in the last two days, to $138.54, a
violent 13% move. Is it those nasty speculators? Are fundamentals at
work? Is the world worried about Israel bombing Iran? There are
numerous factors involved, but the combination produced a kind of
perfect storm in the trading pits. Let's look at several items and see
if we can find a connection.
First, there is a real connection
between the price of dollar and the price of oil. In dollar terms, oil
rises as the dollar falls and vice versa. The weak dollar policy that
this country has had (in spite of denials) is having an effect. This
week, Ben Bernanke took the very unusual stance of commenting on the
weakness of the dollar and its possible role in inflation. Typically,
the value of the dollar is the responsibility of the US Treasury
Department, and the Fed does not get involved. You can bet that
Secretary Paulson knew in advance and approved Bernanke's statement.
That put a bid under the dollar and hit oil and commodity prices in
No one should think that the Fed or the Treasury is
getting ready to intervene in the market, which would be a rather
futile effort. Rather, it was a clear signal that the Fed is "on hold"
and is unlikely to lower rates in the current environment. Since the
market felt that the next move from the European Central Bank (ECB)
would be to lower rates in response to a weakening environment in
Europe, that served to push the dollar higher against the euro.
that a German 2-year bond pays 4.64%, and the US 2-year note pays
2.39%. That difference helps put a bid under the euro. Also, note that
interest rates in Europe are starting to get flat across the curve.
as the US markets opened on Thursday, Jean Claude Trichet, the
president of the ECB, shocked the markets. Let's let Dennis Gartman
rewind the tape for us:
"Mr. Trichet made it clear that a
number of ECB policy committee members actually support raising rates
very quickly, and he suggested that the committee could move to raise
rates as soon as the next policy meeting in the first week of July! Mr.
Trichet said yesterday that
" 'after having carefully
examined the situation, we could decide to move our rates (by) a small
amount in our next meeting in order to secure the solid anchoring of
inflation expectations.... I don't say it's certain. I say it's
possible [for] we had a number of us thinking that, all taken into
account, all information, analysis of risks, we had a case for
increasing rates... A number of us considered that there was a case for
increasing rates, but later some amongst us considered there was not
necessarily that case... [yet].'
"Mr. Trichet went on
further to say that the ECB is on "heightened alertness" about
inflation. At recent meetings Mr. Trichet has made it clear that the
decision to keep policy steady was unanimous, but yesterday he said the
decision was a consensus, and was not a unanimous decision. That
obviously suggested that some on the committee were already voting to
tighten, and that, we must admit, caught us off-guard. At the question
and answer period following the meeting, Mr. Trichet was asked,
following his statement that the decision to hold rate steady was a
'consensus,' why the committee had not moved to raise rates. He said
that firstly the committee had to signal to the market that it was on
the alert; that the debate had shifted from dead center to the edge;
that the needle on the monetary tachometer was moving off of top-dead
centre. We do not wish to parse things too severely, but it does seem
that the committee is prepared to move at the next meeting, and that is
a material change from our perspective, for we had thought that the
Bank was poised to do nothing for several more months, and that the
next move would instead have been to ease, not tighten. Clearly we had
that wrong, and now the facts have changed."
It is not
just Dennis who was caught off guard. The entire currency and commodity
futures trading markets were surprised (including your humble analyst).
The euro exploded up from $1.5395 to $1.5555 in a matter of minutes.
Oil rose $6. Gold and grains moved violently. Soybeans "gapped," as
commodities of all sorts responded to a weakening dollar.
If Trichet wanted to "signal" the market, it worked. He got everyone's attention very quickly.
There was a lot of short covering in the various markets, but especially in oil. But let's dig deeper.
have been pondering for a few weeks about whether the long-only
commodity index funds are really affecting the markets. Basically,
these funds have become a huge part of the commodities market. It is
clear that enough buying and in size will affect any market, but these
funds do not take delivery. They "roll" their exposure as they get
close to expiration, so they are not involved in the spot price. In
theory, the spot price should be a function of immediate supply and
But, it is not that simple, as Louis Gave reminded me.
Looking at recent CFTC data, investors known as "commercials" were long
827 million barrels of oil. In the early part of the decade it was
3-400 million barrels. Commercials are supposed to be those who are
hedging their production of oil. But large oil companies rarely hedge,
and smaller producers only hedge a portion of their oil (see more
below). Has supply increased over 100%? I think not.
Where is the
increase in commercial interest coming from? The clear answer is
long-only commodity index funds and ETFs. They simply buy baskets of
commodities at whatever the price is, speculating on the rise in the
price of the overall commodity market. It is a one-way trade. Jim
Rogers is probably the most famous exponent of such trades, but there
are scores of funds which mimic what he does. But there are limits to
how much exposure speculators can buy, because the CFTC will allow a
speculator to only buy so much of any given market, to keep large
players from getting a corner on the market and driving up prices, a la
the Hunt brothers and silver in 1980. These limits are known as
There are no position limits for commercials
who are hedging. They are in theory hedging their physical exposure to
a given commodity they are selling or buying. Think of a farmer and
General Mills. Both want to lock in the price of wheat so they can plan
for the future. Speculators are useful in that they provide liquidity
to the markets. In fact, they are essential to a properly functioning
The CFTC created a loophole when they allowed investment
banks to be classified as commercial investors. So, when a long-only
commodity index fund wants to buy a million barrels of oil, they can go
to the investment bank, who will sell them a "swap" on the price of
oil, and then immediately hedge their exposure in the futures market.
be sure, the long-only index fund can now create positions far in
excess of the position limits that are enforced upon normal
speculators. These funds can grow to be huge - multi-tens of billions
of dollars. Even though they are speculators, they are not included in
the data as speculators. Because they get their exposure from an
investment bank, they are ultimately listed as a commercial. In total,
they represent an enormous part of the commodities markets. But they
are providing liquidity, so what's the problem? They are not actually
hoarding the commodities. The price is still set at the spot price. But.
that is not the whole story. They are making it difficult, if not
dangerous, to short the market. When massive buying comes into the
market, it moves the market and sends the signal to the market that
prices are rising. Momentum players move in, and prices rise some more.
fact, as the price of oil has risen from $90 to $100 and higher, normal
speculative open interest has declined, as who can afford to fight the
tape? At the least, I expect the CFTC to require those "commercials"
that are really long-only index funds to provide transparency.
Politicians are demanding that something be done. It is entirely
possible that they will impose position limits on the long-only funds.
As I said last week, when the elephants are dancing, the mice should
leave the floor. And Congress and the regulators are very serious
elephants indeed. Let's hope they do whatever they are going to do
I think smaller investors should take the profits they
have made over the last few years in these funds and move to the
sidelines until it becomes clear what the rules are going to be. Let me
also make it very clear that I am only talking about long-only
commodity index funds. Funds that are managed by commodity trading
advisors which can go both long and short have the potential to profit
from volatility (and of course, they can also lose). In these types of
markets, I like funds which are "long vol." (To be long volatility
means you have the potential to benefit from volatile markets.)
let's look at how the credit crisis is contributing to the problem.
Let's say you are a small oil producer or grain company. You go to the
futures market and hedge your oil production or the grain in your
silos; and if the price goes up, you don't care, because you are going
to deliver the grain at a cost you already know. But there is the
matter of that margin call, and you need to borrow from your local bank
to meet that call.
You are hedged. Your profits are locked in at
some point in the future. But the margin clerk is calling today. And
your bank is having a small problem with its capital base. What is the
cover story in the Wall Street Journal today? "Real Estate Woes
of Banks Mount." Banks, mostly smaller ones, may have to write off as
much as $165 billion in bad real estate loans made to developers and
commercial builders. Regulators are "encouraging" banks to raise
capital and increase their lending standards.
So banks have less
capital to lend. Your banker looks at you when you ask for more money
to meet those margin calls, and says, "There are two types of problems.
Mine, and not mine. Yours is of the latter variety." And you have to
cover your hedges. Enter the margin clerk (the person who calls you and
tells you to come up with more money or they will sell out your
position at whatever the market price is.)
When Bubbles Collide
what happens? Bernanke talks the dollar up and commodities and oil go
down. Two days later a French president of the ECB gets inflation
religion and the markets react swiftly. Commodity prices rise and more
money comes into the market. Traders start covering their shorts as
quickly as possible.
Then this morning, the margin clerks of
the world go to work and oil spikes as the pits smell blood. Morgan
Stanley issues a call for $150 oil in July. The euro rises to $1.5778!
Interest rates drop. The stock market falls large at the open.
rumors of an attack on Iran? An Israeli politician says that Israel
would need to bomb Iran to keep them from getting a nuclear weapon,
just as it becomes clear Obama might be the next president and would
not act to prevent such a problem?
Who can aggressively short
in this environment? In a conversation with Dennis Gartman this
afternoon, he commented that it felt like the NASDAQ. But is it 1999 or
2000? The oil market will continue to go up until it doesn't, and no
one knows when that is. It will continue to rise until all the shorts
that are not strong hands have been covered. The margin clerks are in
control, and they will have their way. Was it all over today? I rather
I wonder if some of the majors aren't tempted to sell
some of their production at $138? I mean, really. If you don't think
that is a reasonable price, and they tell us they don't, then why
doesn't Exxon just go in and start taking all the bids they can? They
and the other majors would be the ultimate strong hand. But then, what
do I know?
Central banks, short covering, a respected analyst
issuing a near-term call for a $20 rise in oil, conspiracy theories and
Iran, long-only funds buying, everyone scared to short, margin calls,
and a credit crisis all give us the perfect storm.
Add to that
the ugly employment numbers, and the Dow drops almost 400 points. The
S&P 500 violates all sorts of technical signals to the downside.
The market sold off big at the close. Monday should be interesting.
quick points. I think oil is lower at the end of the year. Inflation in
Asia and rising subsidies are going to force more and more Asian
countries to allow the price of oil to rise and send the proper signals
to consumers to use less oil. Over the next decade, oil will be much
higher, but I think the pressure over the next year will be to the
downside. But don't ask me how high it can go in the short term. Ask
the margin clerks.
America on a Diet
corn is going to go higher. Bad weather has meant that not enough got
planted, and that will probably hurt yields in the fall. This is going
to mean even higher meat prices and ethanol prices. Corn ethanol is
such a bad idea. This is what happens when government decides to mess
with the market.
Anecdotal inflation note: I eat two chicken
fajita pitas without cheese from Jack-in-the Box for lunch about three
times a week (after the gym!). I throw away the pita bread and just eat
the chicken at my desk. The last three days the price has been the
same, but the amount of chicken is noticeably smaller, perhaps 25%
smaller. Where's the hedonic price adjustment in the BLS statistics for
that? A friend of mine notes that the filet from his favorite steak
house is now seven ounces instead of eight. But the steak is still the
same price. Maybe portion control will finally get America to go on a
Finally: George Friedman told me that the Saudis are taking
in something like $10 billion a week! The entire gulf is awash in
dollars. He thinks it may have nowhere else to go but to the stock
markets of the world. We'll see. Unintended consequences.
Montreal, A New Book, and a Wedding
week Tiffani and I go to Montreal to speak at a conference for
Canaccord, and we will get to have dinner with Martin Barnes and Pierre
Casgrain. And it looks like Dennis and Margaret Gartman may be able to
join us. Now that will be a fun dinner. I should get some fodder for
next week's letter.
(my daughter, who in fact runs the business and lets me research,
travel, speak and write - what a deal!) and I are going to take the
train from Toronto to Montreal so we can work on a new project.
Basically, she has an idea for a new book that we can write together,
and we are going to use the time to think about how we go about it. But
we are going to need your help. I will let you know in a week or so,
but it is going to be great fun for all of us.
And speaking of
Tiffani, she is getting married to Ryan on August 8 (08-08-08). Plans
are coming together, as well as expenses. This is going to be a most
different wedding, as those of you who know Tiffani might suspect. Not
traditional at all. One of the best photographers in Dallas has been
working with them. Because they are willing to try different things, he
is getting them to do things he has always wanted to do but never had a
couple adventurous or "fun enough" to do. The following photo is just a
sample. This is a groom that is definitely in for a challenge. If you
want to see more pictures (the underwater photos are fun, the
"Hillbilly Tiffani and Ryan" is a hoot) you can go to www.fatedlove888.com and click on the picture. Dad is only a little proud.
are 20 college-age kids from my daughter Amanda's cheerleading
instruction team at the office watching the baseball game, and three of
my other kids. (You can watch the game from my office balcony.) Of
course, the Rangers are losing. I am literally writing with foam ear
plugs, trying to concentrate, so I think I will just hit the send
button and enjoy my kids.
Your doing my best to stimulate the economy with wedding expenses analyst,
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INFORMATION TO INVESTORS, MAY INVOLVE COMPLEX TAX STRUCTURES AND DELAYS
IN DISTRIBUTING IMPORTANT TAX INFORMATION, ARE NOT SUBJECT TO THE SAME
REGULATORY REQUIREMENTS AS MUTUAL FUNDS, OFTEN CHARGE HIGH FEES, AND IN
MANY CASES THE UNDERLYING INVESTMENTS ARE NOT TRANSPARENT AND ARE KNOWN
ONLY TO THE INVESTMENT MANAGER.
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