9/10/08 (Lehman Done? Where's the Gold? Fiat Money!)

Traders,

 That euphoric rally that the government stepped in and bailed out Freddie and Fannie only brought ONE THING to the table – CERTAINTY! Certainty that they would bail them out, but that doesn’t solve the problem, it just shifts the risk off the balance sheet of the company (and the shareholders) and dumps it on the tax payers – GREAT! It also doesn’t change the economic landscape of this country and the credit risk that is mounting. That problem is VERY simple – writedown 100% right now and find the bottom on the balance sheet. So why don’t they do that? Because of leverage, the positions are so enormous that they can only writedown a little at a time and stay in business as the borrow money from the discount window, sell assets, and beg sovereign funds to invest. So that means just long drawn out bloody quarter after quarter of write downs.

                Yesterday the market came all the way back from the hyper-knee-jerk rally. Talk about volatility and whipsaw – this is the market right now – not bull, not bear – just euphoric up moves chased by short covering (talking heads saying the worst is behind us) – followed by the panic and realization that it’s not. The VIX as I have been saying has NOT been indicative of these kinds of moves and the hidden volatility continues to mount and pokes it head out every now and then to show its teeth!

                Expect more of the same. I hope I am wrong, but I think currently the best we can hope for (regardless of who the next president is) is Stagflation and a no growth 2009 – but that is looking less likely as the debt continues to mount. Recession is in the cards and more write downs are too come.

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Lehman – done YET?

 Yesterday I mentioned Lehman’s panic to sell its core business (obviously the Korean Bank takeover rumors are just that rumors) – and realization quickly came as we saw the stock take a massive hit yesterday (almost 50%). They are done – if not for being able to go to the Discount Window for some short-term money to get that balance sheet alive.

                Today they release their “Strategic Initiative” – just a fancy word that means we are going to report another massive write down and we are going to tell you how we are going out of business by selling off large chunks to stay afloat hopefully long enough for someone to buy us.

                CEO Richard Fuld is probably one of the most respected Wall Street CEOs, he brought Lehman back from death in the in the past, remained independent, and help rebuild the company. The scary thought is that if he IS so well respected – why can’t he make the deal (a take-over or strategic partnership) and WHY did he let it go this far? Was it his stubbornness to remain independent – he knew the writing was on the wall after Bear Stearns – you know he must have had some idea of his balance sheets. If he can’t make a deal – then who can.

                The loss of $3.9 billion (was expected) for the quarter, the cut of the dividend to .05 (annualized), and talk about considering all strategic possibilities – means he just hung the “For Sale” sign on the door.

                Here is the next question that no one is asking – Lehman is going to the Discount Window to float its balance sheet. Remember, Bernanke said to Congress “These are NOT investments, just short-term loans – they have NEVER failed!”. That window to non-members is suppose to close in January and while Bernanke said he extended the borrowing from 30 days to 84 days – I seriously don’t think Lehman can pay it back. That leaves TWO possibilities – first Lehman defaults (screwing over the Fed – and tax payers) OR Bernanke extends the loans and the window AGAIN! Either way it is NOT a good sign of things to come.

                Does our government start nationalizing banks too? Our government is NOW in the mortgage business. It looks like the DMV will have two new windows – the Mortgage Window and the Bank Window!

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Consumer spending coming to a halt.

  The stimulus checks have been spent, homes continue to decline, credit lines are tapped, and jobless claims are up – yeah it’s not a rosy picture. It also means consumer sales are on the decline. The biggest part of our economy is consumer spending and when that slows – expect to see a wider slowdown. This also means the FED will probably leave interest rates unchanged (regardless of inflation data) for the rest of the year. Some economist are even talking about the possibility of another cut! I don’t know why they would think that would “jump start” consumer spending – that credit line is tapped. When money is tight – the rates do NOT matter – you just can’t borrow.

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Silver and Gold

 As you know I have mentioned that I was a buyer of Silver if it hit $12 an oz. Well it broke through that – the problem is I have a pocket full of money and I can NOT buy ANY silver. The US Mint as well as several other mints has officially announced they have stopped issuing 1oz Silver and Gold coins. In August they sold a record 63,000 oz of 1oz gold coins and then shut the doors. Wall Street Journal reported the mint was out of 1oz gold coins, but does that mean they are out of gold or just out of minted coins and they have stopped minting more? Who knows. It’s true since we have come off the gold standard that the US government has been selling off its gold and silver reserves (obviously if they are selling gold and silver coins), but also a broad in large quantities. It’s another way to raise much needed money and unlike issuing treasuries they don’t have to pay it back with interest.

                But here is the conundrum – the silver and gold ETFs are getting hit hard and so are the futures. The laws of supply and demand would dictate that if gold and silver prices are crashing down that would mean there is MORE gold and silver to buy. However, that is NOT the case. SLV and DBS (two silver ETFs) do NOT actually OWN very much (and in the case of DBS NONE) silver. They are simply ETFs that TRACK silver and they are funded by other PAPER that promises to deliver silver (either through futures or OTC contracts). Essentially you are buying paper that is backed by more paper – but not the actual physical asset. Additionally – we are seeing massive increases in SHORT gold and future positions. One estimate has calculated that it would take the entire world’s silver mines over 100 days to meet the short future contract obligations.

                So here is the rub – you can’t SHORT physical silver or gold, but you can PAPER silver and gold. There are actually TWO markets – the paper market and the physical market. If you want to go buy any silver or gold (if they have it in quantity) you will be paying more than 20-50% above the current spot price. The two largest gold and silver dealers have announced they are out of any quantities (since the mint has closed down). You could always BUY a future contract of silver (5000 oz) and take delivery – which is rather hard to do – there is all the paper work, going to NY to the warehouse, matching serial numbers, getting clearance from the clearing firm, etc. They would REALLY prefer that you did NOT take the ACTUAL silver out of the warehouse and you SHOULD be satisfied with having the contract that you OWN some in the warehouse. Also, 5000 oz (actually deliverable in 1000 to 1100oz bars) is almost 400 pounds of silver – not as easy as buying 1oz coins.

                The other thing that concerns me is the ETFs – remember these are backed NOT buy the physical gold or silver (totally), but in many (most) cases by more paper. They are also issued by some of the very banks that are going through serious credit squeezes and looking the raise capital (like Barclays). So how SECURE is the ETF if it is just backed by OTHER paper – and if that paper is just OTC paper (like at Bear Stearns) it’s worth pretty much NOTHING. A contract is only as good as the credit between the parties – and that is not looking so credit worthy any more.

       Why am I concerned? Because I really think our currency (paper money) – a FIAT currency is getting seriously tested. The government is taking on MORE debt ($5 trillion in liabilities from the GSEs), Discount Window lending 100s of billions – to the likes of Lehman, Secondary Treasury auctions are failing (even the market makers are leaving), and the government is trying to print (devalue) our way to prosperity (taking on more debt to keep people afloat). The dollar has rallied – but I seriously think that is a short-term FAITH rally – nothing more. I think we could see the dollar seriously contract and get the squeeze. Remember – our nation lives off of borrowing money from foreign nations. Yeah – the government is borrowing money (just like consumers and companies) and just doubled the debt load. You think a nation like China (one of our biggest creditors) wants to buy MORE dollars (treasuries) to get paid 2-3% when our government even says inflation is over 4%? That is a losing trade.

                                I have sunk to buying “dirty silver” (half dollars, quarters, dimes – pre 1964) – and that is IF I can even get any of that  - also has dried up.

      I would love to buy more SLV – I just don’t know if the credit behind that is worth it – especially since I can NOT take actual physical delivery. Next stop – futures and 1000 oz bars. Does anyone have a big truck I can borrow – I’ll be making a road trip to New York next expiration cycle.

                My bet – the dollar is going to fall after the elections – maybe not until early 2009  - unless something SERIOUSLY changes.

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Futures Pre-market

                The futures were up big coming waiting for HOPEFUL news on Lehman – but that was more of the same and they have pulled off some. They are back up a little going into the opening – but it seems more noise and speculation. Arb traders will short the futures as the spread widens going into the opening – expect a pop in the market if the spread remains as they buy the basket into the opening to cover the Arb.

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Support / Resistance

                Back to the support level?

INDU 11,250 / 11,500 (IF we don’t hold the 11,250 area we could be visiting the 11,000 area and THAT needs to hold. I think 11,000 is in the cards – maybe not today – but so far the WORST is really not behind us.)

NDX 1700 /1750 (We could get back up to the 1800 area by expiration – but that is going to be a tough road as it has put in a serious ceiling there. 1700 is support and we are seeing action in this range. I wouldn’t be getting SHORT at 1750 – but just neutral. Expect more volatility – pre-market we are looking higher – but that could change.)

SPX 1225 / 1250 (Yuck – we gave back two days of huge gains are closed lower – sure the futures are showing a pop at the opening. I think we WILL see 1200 unless we can get some seriously good cheerleading coming back to the market.)

RUT 700 / 720 (We are now at that 700 range and the broader market has held up very well versus the narrower based indices. 700 is key to hold – do NOT get long hard deltas there – gamma at 700 is good. We could rally off that – the futures are showing a rally.)

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Conclusion

                The silver/gold/dollar thing has me not only scratching my head – but also very concerned – really for the first time about our fiat currency. How much more debt can the nation take on, GSEs, Discount Window, FDIC, etc. I think we ARE tapped out – sure it would be GREAT to bailout everyone and everything – but even if we DO raise taxes on everyone – it will barely put a dent into the national debt. We can’t even get a REAL Budget anymore – as liabilities are consistently moved off the balance sheet. You really think Congress is going to put on the $5 trillion dollars of liabilities from the GSEs on the balance sheet? Of course not. Even the 100s of billions at the Discount Window are not included. However, anyone that passed basic math can add the numbers.

                The government needs to CUT costs now – be it the war, programs, middle management, staff, etc. It is just not sustainable. Sure we have a printing press and can just BELIEVE we can print our way out – but that is the express way to hyper inflation – have you seen Zimbabwe? Not saying we are going that route – that is an extreme – but hey – having a Fiat currency means being Fiscally responsible – something that nether the Democrats or Republicans can actually hang their hat on. It’s not about party – it’s about government!