Barron's Called The Top On Oil, too.

The cover article for the last week of June in Barron's was titled:
Bye, Bubble? The Price of Oil May be Peaking.

The article is dated on their website: June 23, 2008. The subtitle:

The price of oil may be peaking in the current range of $130 to $140 a barrel. Here's where you want to be when the bubble bursts.

Their timing was impeccable. Although it wasn't July 9, 2008, it was very close.

I must admit, it was quite bold, with a bit of daring, for a big publication such as Barron's to be calling a top. Generally, financial journalism involves more reporting, and less analysis. So kudos to Barron's, you win!

Some excerpts:

"My basic message to those who say that prices have to go up forever is that the oil markets have been cyclical for 140 years. Why should that have stopped?" says Edward Morse, chief energy economist at Lehman Brothers.

It is hard to argue that oil demand supports $135 crude. Now at 86 million barrels a day, global demand could show little or no increase this year after averaging 1% gains in recent years. Sanford Bernstein analyst Neil McMahon projects that by the fourth quarter, global oil demand could be running below the fourth quarter of 2007.

OIL-MARKET EXPERTS ACKNOWLEDGE THAT commodity-indexing strategies employed by endowments, pension funds and other institutional investors have helped push up prices in the past year. Such investments are thought to have totaled $260 billion as of March, up from $13 billion at the end of 2003

I just want to make a big point out of the last quote about institutional investing in oil. So many people have blamed the "speculators" for this price run up. But the line between being an investor, and being a "speculator" is very, very fine.

From, our friendly Wikipedia:

Only if one may safely say that a particular position involves no risk may one say, strictly speaking, that such a position represents an "investment."

How many stocks do we know of that involve absolutely no risk? Zero.

In a sense, we are all speculators. We do things based off of assumptions and predictions. But, it takes huge sums of money to really move the commodities markets. And huge sums of money only come in if their is at least a bit of a rational explanation for an investment.

For the housing mess? It was the AAA (Triple A) credit rating associated with many of these subprime filled mortgage backed securities. And for the oil "speculation" it's the falling dollar, and the fact that the world is becoming more like the United States. Full of gas guzzlers.

The term speculator gets thrown around by countless politicians, with 90% of them not understand what one really is. And it developed this extremely negative connotation. But if you want someone to blame for high oil prices, then listen to Barron's. Blame the speculators. Blame the pension funds and university endowments. Freakin' Harvard!

OH, and by the way, if you read the post Why Oil is Still So Expensive you'll see that I also mentioned something about a bubble popping:

I don't fully understand the whole picture because I don't fully believe the picture being presented to me. Either way for me, curiously odd price action tends to mean bubble popping soon.

I'm just saying. =)

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Did Fox Business Ruin the Market?

Now, I'm not crying out against conservative journalism or anything. Heck, I won't even go so far as to say that Fox News is a conservatively biased network. They are what they are.

And the facts are what they are as well.

Before Fox Business launched the stock market was hitting all time highs. We had taken a hit from the subprime mortgage debacle in July 2007, but bounced back on the wings of Ben Bernanke's surprise 50 basis point rate cut. Everything was zooming up. Especially large-cap tech like Google (GOOG) and Baidu (BIDU).

And then on October 15, 2007 Fox Business began its first broadcast. On that day the S&P 500 was at 1,550. Today it stands at 1,260.

Possible reasons for this correlation?

• Fox Business claims that it takes on a "pro-business" stance. Investors see that it's ratings are low. Therefore people must not like business right now. Sell!
  
• China doesn't like Fox Business. Investors there had nightmares of Bill O'Reilly from Fox News incessantly arguing irrationaly, and decided to sell. The collapse of the Shanghai market then spread over to the U.S.
• CNBC's Erin Burnett and Maria Batiromo felt threatened by the "Foxes" on the Fox Business like Alexis Glick and Jenna Lee. Thus, they are now embittered and are very negative toward news and guest CEOs. Investors see this negativity, interpret it as a lack of optimism. Burnett and Bartiromo are consumers, so consumers must not be optimistic. Therefore, the economy is going to tank. All the mutual funds proceed to sell.

Any other possible reasons for this correlation? We need to get to the bottom of how Fox Business tanked the market!



Disclosure: Correlation doesn't equal causation.

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Should the President be an Economist?

It's a very natural thought process to think that the person at the helm of the United States, who is the leader of the current leader of the world, should be an economist. After all, who better to understand the global consequences of his/her decisions?

Contextualizing decisions into a macroscopic viewpoint is a really big issue for a president in particular. It's hard to think globally, when the people that elect you are primarily thinking about themselves. They're not thinking domestically, they're not thinking about their state, or their city. Let's face it, for the most part, voters will vote for who they believe will increase their own standard of living the most.

This is sad, but it's true. In reality, Wall St. isn't that different from Main St. Everyone is greedy. But that's okay! We just have to accept it, understand it, and work around it.

With globalization ever more advanced, what may seem like good domestic decisions for the short term, can easily work its way around the world and ultimately bite us in the derriere (that's French for butt). See: Ethanol, the Farm Bill and commodities prices.

And with this in mind, Harvard Economist, Gregory Mankiw, wrote the following article for the New York Times: What if the Candidates Pandered to Economists?

I'm going to list for you the things Mankiw describes Presidential candidates should do to cater to economists, and the general stances of the two main candidates, Barack Obama and John McCain.

• Support Free Trade
  • Obama: heavily against NAFTA
  • McCain: relatively for it
• Oppose Farm Subsidies
  • Obama: one of the Farm Bill's biggest supporters
    
  • McCain: against the Farm Bill
    
• Leave oil companies and "speculators alone"
  • Obama: wants to investigate and regulate
    
  • McCain: wants to investigate and regulate
    
• Tax the use of energy
  • Obama: not necessarily wanting to raise energy taxes, but opposed the "gas tax holiday"
    
  • McCain: wanted to repeal taxes on oil this summer
    
• Raise the retirement age to deal with Social Security
  
  • Obama: raise taxes for wealthiest to support social security
    
  • McCain: decrease taxes, let individuals manage retirement
    
• Invite more skilled immigrants
  • Obama: catering to Latino vote, wants to legalize illegals
    
  • McCain: catering to Latino vote, wants to legalize illegals
    
• Liberalize drug policy
  • Obama: not clear, probably against it
    
  • McCain: not clear, probably against it
    
• Fund Economic research
  • Obama: yet to act on this matter
    
  • McCain: yet to act on this matter
    

I encourage you guys to read the whole article over at the New York Times for further detail into what economists really want from one of the leading economists in the nation. Although, the drug policy part seemed a bit silly. I mean, if he wants to associate personal freedom with marijuana use, why not heroin use? Or smoking and drinking for minors?

I think that there is a certain point where freedom must be controlled to take into account human faults. That's a big reason why we can't let the markets run completely wild. Otherwise, we'll have a housing implosion every 6 months.


Disclaimer: I'm an independent. Although, I have bias. Everyone has bias, unless they're liars.

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What are Fannie Mae and Freddie Mac? How is the government involved?

They've been in the headlines since the beginning of this whole financial crisis. You know that they are somehow associated with mortgages, but what is it that they really do?

Let's get the BIG issue out of the way first. Their names.

• Fannie Mae (FNM) is the nickname for the Federal National Mortgage Association.
  
• Freddie Mac (FRE) is the nickname for the Federal Home Mortgage Corporation.

Economists and finance and business people will often refer to these organizations as Government Sponsored Enterprises, or GSE. This means that while that while they are private corporations, and thus publicly traded, their assets (and liabilities) are government (publicly) owned.

Does that sound confusing?

It's funny, because a private corporation is publicly traded. But it isn't publicly owned. Only government organizations are truly publicly owned, albeit by no choice of the public.

The main idea is that Fannie Mae and Freddie Mac are private corporations, but come with the following special government links:

• They are federally charted (vs. private incorporation of a company)
• The president can appoint 5 of the 18 board members
• They have a federal line of credit from the U.S. Treasury of $2.25 billion
• They are exempt from state and local income taxes
• They are exempt from SEC reporting requirements
• Their securities are government securities

For a bit of history, Fannie Mae is the original and was created under FDR's New Deal in 1938. Fannie Mae was privatized (with the government links above) in 1968. Freddie Mac was created in 1970 in order to further expand the secondary mortgage market.

So how do they make money?

Fannie and Freddie both specialize in the "secondary" mortgage market. The primary mortgage market is controlled by mortgage originators such as Countrywide Financial, now a division of Bank of America (BAC), or IndyMac Bank (IMB).

Fannie and Freddie both purchase mortgages from the primary market, and often repackage them into mortgage backed securities (MBS) to be sold again. As dicussed in the post on Mortgage Backed Securities, this secondary market allows for mortgage originators to have significantly more liquidity, and issue out more mortgages.

When they sell Mortgage Backed Securities, Fannie and Freddie both guarantee the timely payment of principal and interest on them. For that, purchasers of mortgage backed securities will pay Fannie and Freddie an anual fee of usually 0.2% (20 basis points) on the outstanding principal.

Fannie and Freddie may also purchase mortgages and simply hold them. Collecting the payments as a source of revenue.

o.2% doesn't really sound like much. But when both of them combined own/gurantee 50% of the $12 trillion mortgage market, you get around $40 billion in 2007 revenues for each. Of the approximately $6 trillion in associated mortgages, $5.2 trillion is through guarantees on mortgage backed securities.


What has really been making news lately is the murmuring that there will be a government takeover of these two entities. Purchasers of mortgage backed securities during the housing bubble didn't worry about the chance of Fannie or Freddie defaulting because they saw an implicit government backing. Thus, despite the housing market looking increasingly bubbly, and despite the knowledge that Fannie and Freddie owned so many of these risky assets, buyers of MBS's were confident that they would receive their payments.

So they would continue to buy MBSs. Which fueled an even larger housing bubble. Which caused the huge housing crash. Which brings Fannie and Freddie to single digit share prices.

The VIP (very important point) of this whole discussion on Fannie and Freddie is that the government backing is in fact implied. Up until now this implication has never really been tested. However, it seems like the assumption holds true, with the Bush Administration outlining a plan to rescue the two GSEs.

This latest bailout has spurred even more discussion about the US becoming more and more socialized. It almost feels like the 1970's all over again.

We have high oil.
We have a recession.
We have inflation.
We have central planning vs. free markets!

Fellow Dudes, we even have the return of Abba.

Remember. Freddie Mac makes home possible. Or. Whatever.


Further readings:
http://www.cato.org/pubs/pas/pa528.pdf
http://www.economics.harvard.edu/faculty/mankiw/files/fanfred_ft.pdf
http://hnn.us/articles/1849.html
http://en.wikipedia.org/wiki/Federal_National_Mortgage_Association
http://en.wikipedia.org/wiki/Government_sponsored_enterprise

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Jerry Yang, I'm Here For You

Pictures like these need no words. Except of course, a caption. That's Yahoo CEO Jerry Yang with his head down while talking to Google founders, Sergey Brin and Larry Page.

These pictures come courtesy of Reuters.

Man Google is being a bully. What's with the 2 vs. 1?

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Why Oil is Still So Expensive

We all knew, or at least most of us thought that the oil prices were indeed getting bubbly. The current situation of supply and demand didn't seem to warrant such an extended run. The question really was when would the pain for consumers, or pleasure for oil investors, stop?

What I thought was particularly of note, that really made me feel like we were approaching a top, was when oil shot right through $140, right after China announced that it would increase oil prices.

"The price of gasoline was raised by 17% to 6,980 yuan per ton, from 5,980 yuan; diesel prices were raised by 18% to 6,520 yuan per ton, from 5,520 yuan; and jet-fuel prices were raised by 25% to 7,450 yuan per ton, from 5,950 yuan."
the source

The hidden secret was that China needed to increase prices so that its two main oil refiners PetroChina (NYSE: PTR) and Sinopec (NYSE: SNP) would stop losing so much money.

And that was the primary motivation for the Chinese government when it made its decision to raise prices, said Sun Mingchun, economist with Lehman Brothers.

"The main reason was to make sure China has enough fuel supplies during the Olympic Games," he said, "because the price controls have distorted profit margins."

In a note published shortly after the price rise was announced, Goldman Sachs also said that "the price hike could lead to normalization of supply versus the recent rationing of sales at the pump."
the source

Since topping out at a market cap of $1 trillion dollars in October, PetroChina has been in a freefall. It's share price of $126.79 gives PetroChina a market capitalization of $232 billion -- just short of a 75% drop in value.

Other than the bubble being imploded in China, the reason PetroChina has seen such a steep drop is that in recent quarters it has only been losing money for each barrel of foreign oil it refines and sells to domestic (Chinese) consumers. The cap on the oil prices that the government placed means PetroChina and Sinopec will continue to buy oil at the current exorbitantly high prices and won't be able to pass along the price increase to consumers.

"Sinopec said earlier its refineries would break even if oil prices fall back to $76 a barrel or below."
the source

As we all know, crude oil prices are not even close to $76. But state-owned means state motivated (kinda sorta) and China needs oil to fuel its growth. Therefore Sinopec and PetroChina have both been refining oil at a loss. (Note: Sinopec imports 80% of its oil, while PetroChina imports 20-30%)

So when Goldman Sachs says that the price hike could result in a "normalization" of supply, this is meant relatively. The reasoning is that if PetroChina and Sinopec can charge more for their refined oil, they will be more motivated to refine it!

What personally strikes me as odd however, is that if these operations are state-owned in the first place, then why would they need these seemingly "superfluous" motivating factors to refine oil. If they were already refining it at a loss, what would a 25% (just for generous estimates) cushion really do?

Sinopec has stated that they need oil to trade at $76 a barrel to break even. A 25% increase in their selling price would then require them to have $95 a barrel oil to break even. Currently we sit at $140 oil.

Further inhibiting the effects of increased pricing cooling down demand in China is that the Chinese government is now offering oil subsidies to industrial consumers so that they continue to purchase oil:

Shortly after the NDRC announced the price rises, China's Ministry of Finance said that it would provide 7.8 bln yuan in fuel subsidies to farmers, and a further 12 bln yuan to the urban transport, fishing and forestry sectors.

I don't fully understand the whole picture because I don't fully believe the picture being presented to me. Either way for me, curiously odd price action tends to mean bubble popping soon.

But, I'm second guessing myself because:

For the first time in several months, the International Energy Agency Thursday slightly raised its 2008 world oil-demand growth forecast but cautioned that global crude consumption will remain well-below trend into 2009 amid declining economic conditions.
the source

For oil to come down in price, either demand has to shrink, or supply has to expand. And then, investors need to realize that it's happening. Because it's the investors that set the prices, and its the investors that decide how long the bubble will last.

Right now, even with the price increase in China, investors don't really see either happening.

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Best Economic Periods by President

This was an interesting little graphic I found that I thought I might share. This actually only includes presidents from the 1920s onward.

George Bush (Georgie!!) is making a late push for 3rd worst stock market return this century. Anyone rooting for him to win?

But in all honesty, many times presidents are the victims of circumstance more so than the creators of them. To my knowledge George Bush didn't have that much to do with the mortgage crisis. Really guys, imagine trying to explain to him what a CDO is. C-D-O. See the--oh!!

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NVIDIA is struggling, but so are AMD and INTEL

If you've taken a peek at Nvidia's stock recently (Nasdaq: NVDA) you may have noticed that it is trading at $11.82, down some 33% from a week ago, and down 66% from it's 52 week high. What gives?

Last week Nvidia had a pre-earnings announcement warning that revenues and margins wouldn't meet analysts expectations. Their reason?

"The estimated decrease in revenue and gross margin is due to several reasons: end-market weakness around the world, the delayed ramp of a next generation MCP, and price adjustments of our GPU products to respond to competitive products," the company said in a statement.

MCP stands for Media and Communications Processor. For those that are unfamiliar with the industry, Nvidia is simply referring to a new "platform" for their processors. The big thing here is the "price adjustments of our GPU products." This is because Nvidia has but one competitor, AMD.

Around late last year, when AMD was announcing constant delays to their products, many if not most people counted AMD out of the race for the next generation of chips. But despite all of the drama over people calling for AMD CEO, Hector Ruiz, to resgin, AMD has chugged along and quietly released its next generation mobile cpu + graphics platform--PUMA.

Puma has definitely impressed critics. It is being featured in a brand new laptop from HP called the dv5z. Here is an excerpt from a review of the laptop by NotebookReview.com

In short, AMD and ATI just murdered the low-end dedicated graphics card market. There's absolutely no reason to buy a laptop with a low-end dedicated graphics card like the NVIDIA 8400m GS because the new ATI integrated graphics solution performs just as well (if not better) at a fraction of the cost.

One would imagine that weakness in Nvidia due to competition might mean an uptick in AMD's share price. That isn't the case. AMD although doing well in the graphics department is still lagging Intel in CPU technology. AMD's next generation PUMA actually consumes more battery life than before. This is a huge no-no for laptops, which already don't stay on long enough (mine is about to run out of batteries as we speak!)

Furthermore AMD recently released its top of the line desktop cpu to very little fan fare. The title of the article from Engadget says it all: AMD's flagship Phenom X4 9950 BE announced: Intel laughs, points

As you'd hope from AMD's flagship desktop CPU, the X4 9950 is faster across the board than the previous AMD title holder, the X4 9850, albeit, just 5%

AMD continues to lag Intel in terms of performance per watt as well

Another very logical conclusion is that because of AMD's continued underperformance in the CPU market, Intel might find strength in it's stock. That's also false.

The overall conclusion? Chip makers is not where you want to be right now, as an investor. Competition = lower share prices for all that is involved.

But for consumers, and the rest of the world AMD should serve as a reminder to what competition really means. Cheaper toys for everyone!

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How to Interpret Analyst Ratings

This piece goes along with the post on Merrill Lynch seen here. The previous post was about Merrill Lynch changing its policy on analyst ratings, noting the discrepancy between the number of stocks that were rated a sell/underperform and the number of stocks that actually underperformed the market. If you haven't noticed, barely any stocks are rated a sell.

So, along those lines I present to you an article from Kiplinger's: What Analyst Ratings Really Mean

He counsels investors to use Wall Street research as industry background material and to ignore buy and sell calls, price targets and earnings estimates. That's how the pros use it, he says.

Fill us in a little bit more on how to interpret "buy" and "sell" calls.

It's hilarious. You need a codebook to decode it. When a stock goes from one of those very rare sell ratings up to a neutral, that is a strong buy. When a rating is lowered from a buy to a neutral or a hold, that's a very strong sell.

Obviously, there's a reticence to ever use the big, bad s-word. There are two big audiences who object vociferously to that, and they're the biggest audiences that the brokerage firm has. They're big institutional investors like mutual funds, and they're corporate executives, which is where all the banking business comes from. In fact, only 5% of all the ratings on Wall Street are sells right now in this bear market.

The fact that we can't trust these analysts ratings is common knowledge. Only the most novice of investors don't know this yet. It's okay, I remember when I believed these senseless ratings too. But what did surprise me was that according to the article, most Broker's don't understand this investing "code"

Do brokers who advise individual investors understand the code?

No, not much. They're almost like individual investors. In other words, they use the firm's research -- buy ratings, sell ratings, whatever -- to recommend stocks to clients. They use the firm's earnings estimates and the firm's strategist and economists and so forth, and it's the party line.

Personally, I like to use analyst "ratings" only as a call on the strength of the fundamentals. If a stock is rated a "buy" my first impression is that it is a good healthy company. Now just because a company is strong and healthy doesn't mean you should be investing in it. It is all about the valuation, and whether or not you're getting ripped off. Once you've decided you want to buy a stock you should then look for favorable valuations, or entry points.

For example, the iPhone is a great little device. But if you pay $800 for it, like some people did, is to get your pants ripped off. And if you regret it and try to resell it you will definitely lose money. A more appropriate comparison is Cisco in the tech boom. Even back in 2000, Cisco was a great company with a fantastic long term story. But at a valuation that approached the 100s, you had to be One Flew Over the Cuckoo's Nest to want to buy a share at that price.

There are two parts to purchasing a stock long term.

1. The fact that you believe in the underlying business to perform like it says.
2. And the valuation of the company at which you think you have a "good deal."
3. There's actually a whole lot more to it, but the point of lists is to be concise!

Anyhow, I know many of you like my writing so much that you get lost and you forgot why an article was actually posted. Here's the link I wanted you to read.

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Investors Still Fearless, Relatively. Understanding the VIX

With every new market low, investors everywhere want to know if this low = bottom. In the past couple of weeks the S&P 500 has gone right through the 1280 "line of support" without (wait for it......) any sort of resistance! As we can see by the chart on the right the S&P hasn't been this low since roughly the summer of 2006. We now sit at 1252.31 off of a high of 1576 in Oct 2007. That's roughly 20% chopped right off the top of the market.

The question is, how can you as an investor know when the trend may reverse? Many critics of "technical analysis" will pose the philosophical question of "What's the point of a Support if it doesn't always have to provide support?" "What is the point of resistance, if sometimes it gives no resistance?"

Just to play Devil's advocate, could we not criticize fundamental analysis in an analagous manner? What is the point of a valuation based on fundamentals, if the fundamentals are based on assumptions? What's the point of making assumptions when everyone's assumptions are different, thus making valuations different, thus making valuations anything but concrete.

I agree with both sets of critics. Nothing in investing is concrete! Why? Because, a valuation boils down to what someone else values it at. That's it. The moment, somebody is willing to purchase a share at that price, that is the stock's valuation at that moment. Just like the world is in a constant flux, just like people's psyche's are in a constant flux, just like the news is in a constant flux, prices too, are in a constant flux--and by default valuations are in a constant flux.

Fundamentals are never reliable ( has anyone heard of Analyst Upgrades? or Raising Estimates?). Technicals are never reliable. They are simply tools of the trade of trading. What has been reliable as of late to mark trend reversals in the market is the .VIX. Otherwise known as the volatility index.

Straight from Investopedia:

The ticker symbol for the Chicago Board Options Exchange (CBOE) Volatility Index, which shows the market's expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 index options. This volatility is meant to be forward looking and is calculated from both calls and puts. The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge".

Why does the VIX seem to work? I believe it is because it measures investor sentiment about the market. If we really view the market as what it is -- a bunch of crazy investors frantically trying to revalue everything they own constantly -- then the VIX makes so much more sense. We make the market because we ARE the market. It's like trying to bargain for a good deal. You want to know as much about the other side as possible. The best time to buy is when they irrationally drop the price for irrational reasons.

What do you do when you want to make a Business deal? You get em' drunk! (Just Kidding. This site does not advocate the excessive consumption of alcohol under any circumstances. The previous statement was meant only in good humor.) So what do you do went you want to buy stocks? You make sure the other side is irrational and fearful. AKA You let the VIX spike up.

Peering at the chart above we see that the last significant "spike" in the VIX took place on Mar 17, 2008. This just happens to coincide with the last market bottom seen in the S&P 500. What a spike in the VIX signals is capitulation in the markets. Let's learn more from investopedia shall we:

After capitulation selling, it is thought that there are great bargains to be had. The belief is that everyone who wants to get out of a stock, for any reason (including forced selling due to margin calls), has sold. The price should then, theoretically, reverse or bounce off the lows. In other words, some investors believe that true capitulation is the sign of a bottom.

Once all the investors who want to get out, have sold irrationally the only ones that should be left, are the rational investors. If you are rationally invested in equities for any reason, in essence that means you are bullish on equties (whether it be short term or long term). Although we had a small spike up in the VIX today, I can't say if it is convincing enough to signal a reversal. And noting that the next line of support (I'm using a bit of technical analysis... sue me) in the S&P is at 1226 (only 3% away -- see the S&P Chart above) I feel like we could easily drop to that level.

So be cautious investors, its murky waters out there.

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