I hear it a lot from inexperienced Wall Street analysts, bloggers, and money managers who spend little time living in the “real world”.

Here’s what they’re saying: “Gold is way too popular now… It’s near the end of its bull market.” The recommended “action to take” is to cash in your gold profits and move on to something different.

I can tell you that taking this advice is a big mistake. Anyone who believes gold is too popular with the mainstream public simply doesn’t know who the mainstream public is… and they don’t understand how bull markets end.

Sure… gold is up big since it broke out to a new high in September. In just over two months, it has climbed from $950 an ounce to $1,100 an ounce.

Click here to read the rest of Brian Hunt’s analysis of the state of gold, published online at Fleet Street Invest.

Stock market bulls aren’t concerned about the inevitable acceleration in bank failures — at least for now. Even though deposits will be insured against loss, the loss of local banks will still have a depressing effect on hundreds of small communities. These communities are going to lose their only access to business credit when their local zombie banks — loaded with toxic construction or commercial real estate loans — are liquidated or merged into other weak banks.

Meanwhile, the latest monthly figures show that commercial bank balance sheets are shrinking at a fairly rapid rate, due to a combination of several factors: loan charge-offs, older loans are being paid back at a faster rate than new loans are being made, and regulators pressuring banks to build larger capital buffers.

So credit-fueled growth in consumption or investment is not occurring. Combine this with stagnant or declining wages and corporate profit margins and it becomes hard to imagine how GDP will rebound on a sustainable basis. GDP is the stat that every money manager fixates upon — despite the fact that GDP does not accurately measure true economic progress; it’s like evaluating a stock purely on sales growth, without thinking about what’s driving sales, and whether these sales are sustainable or accretive to wealth.

Nominal GDP is calculated as “consumption + investment + government spending + exports – imports.” Then, government statisticians subtract a highly doctored CPI figure from annualized changes in the above variables to get “real GDP growth.”

Note that all the variables in the GDP equation can be pumped up by excessive credit growth. As I mentioned in the Sept. 4 alert, if GDP is growing at the expense of degraded balance sheets, the end results are never happy. Japan’s GDP stayed higher than it otherwise would have been in the 1990s despite the incredibly wasteful spending on bridges to nowhere. Its policymakers reacted to a huge misallocation of capital into real estate in the 1980s by misallocating capital into government projects and subsidies to favored industries.

U.S. policymakers are following this playbook even faster, only without acknowledging one crucial difference: Japan had a high household savings rate to finance its government deficits, while the U.S. does not. Plus, the U.S. has already “dollarized” the rest of the world, and there are signs international demand for dollars has reached its saturation point.

The gold and commodities markets are reacting to this unpleasant reality. These markets are starting to discount the fact that the Fed will be the aggressive buyer of last resort for all types of debt securities. We’ve likely only seen the beginning of growth in the Federal Reserve’s balance sheet. As long as it can get away with it, the Fed will keep creating new money out of thin air to finance the U.S. federal deficit. Plus, via its liquidity facilities, the Fed and the megabanks will keep swapping Treasuries for legacy toxic securities marked at fantasy levels.

A few wild cards could disrupt this benign “reflationary” environment we’ve been in since the March stock market bottom, resulting in the stock market taking another nasty leg down:

1. If the “audit the Fed” bill were to pass and result in more handcuffs on the Fed, it would help to slow the reckless debasement of the U.S. dollar. But if it put an end to the Fed’s exotic lending facilities, which would force the owners of toxic securities to retain and mark them down sooner, then we could see a return to the January-early March 2009 stock market environment — only most of the damage would be contained to the financial sector as equity of insolvent institutions gets wiped out or diluted.
2. Contraction in the real economy and state governments could easily overwhelm expansion in the “federal government economy.”
3. International holders of trillions in paper U.S. assets could accelerate the rate at which they diversify into real assets. That’s how we could see a spike in “money velocity” that the deflationist camp says is a necessary condition for the CPI to rise. Most of the price pressure will be felt in oil prices, especially later in 2010 and 2011, when today’s underinvestment in new oil projects leads to tight international supplies.

I’d like to bring to your attention one more thing about today’s investing climate, because it’s being used so often lately in the media to justify today’s nosebleed stock valuations: the “money on the sidelines” fallacy. Growth or contraction in the current balance of $3.5 trillion in money market funds depends on how much companies look to borrow in the commercial paper market — not on the level of the stock market, as so many seem to believe.

Those who point to the $3.5 trillion in money market funds as if it’s a bucket that can be “poured” into the stock market bucket to keep the rally going do not understand that money does not go “into” or “out of” the market, but through the market. Trader A sells every share bought by Trader B. Once this transaction settles, cash goes one way and shares the other. The price at which the transaction takes place depends on how badly Trader B wants to own shares, not how many money market shares are in his account.

Also, money market fund balances represent very liquid short-term loans; they reflect an amount of money that’s already been spent in the economy and will be paid back over a very short time frame. John Hussman — one of the best mutual fund managers, in my view — refutes the “cash on the sidelines” fallacy best. It’s worth reading and remembering the next time you hear a talking head arguing that the rally can keep going because of liquidity.

Washington Federal Closes Offering; Now We Wait for Earnings

Yesterday, Washington Federal (WFSL) announced that its secondary stock offering would generate net proceeds of $333 million. This works out to a per share price of $13.79, including underwriting discounts and expenses and assuming full exercise of the underwriter’s overallotment. Here is an example of cash going “into” stocks, because these are newly issued, rather than existing, shares in the secondary market.

As I noted in Monday’s flash alert, I expect the offering will be necessary to absorb a mounting wave of net charge-offs in the future. It’s possible that this offering plan became a necessity after a friendly suggestion from regulators to raise more capital.

On Wednesday, WFSL stock rallied on high volume, but did not reflect organic demand for the stock. JP Morgan (NYSE:JPM) was the sole book-running manager for the Washington Federal offering. Knowing that it would likely receive a few million WFSL shares as a form of compensation in the underwriters’ overallotment, JPM’s trading desk probably established a short position that it plans to cover by delivering the shares it will receive upon the closing of the deal. This likely explains the bizarre trading moves in the stock this week: When institutions were more interested than expected, resulting in a higher offering price of $14.50, JPM likely covered some of their short position.

As for the analyst reaction to the offering, the two analyst notes I saw might as well be corporate press releases, because they expect this new capital to be deployed into an FDIC-assisted rollup of lots of zombie banks in the Pacific Northwest. Also, these analysts cite WFSL’s “strong” capital ratios without adjusting for future credit losses. One might suspect that these analysts have not even read the asset quality footnotes in Washington Federal’s SEC filings.

The big losses WFSL will take on construction loans are obvious, no matter how long management claims it will be able to sit on them. But what’s not obvious to the market — yet — is the rapid future loss formation in its $6.7 billion mortgage book. Management has set aside practically zero allowance for loan losses against its mortgage book. See the chart below for the allocation of WFSL’s allowance by loan type.

WFSL carries a mere $18.8 million loss allowance against its $6.7 billion book of mortgages — a ratio of just 0.28% of assets. The harsh reality of the mortgage crisis tells us that this $6.7 billion asset value is overstated, along with capital ratios (or equity); it should be marked down by far more than $18.8 million. Yet WFSL’s accounting translates as follows: Management does not expect more than $18.8 million in cumulative credit losses in mortgages (defaults, net of recoveries after foreclosure) through the rest of this credit cycle, despite the fact that the majority of these mortgages are now underwater and the job market remains weak.

As you can see in the chart, the ratio of loss allowance to nonperforming loans (by category) has shrunk dramatically. In December 2007, WFSL’s residential mortgage loss allowance was $13 million, and its nonperforming mortgages were also $13 million. As of June 30, this loss allowance had been built up to $18.8 million, but nonperforming mortgages had grown to $119 million (and will keep growing). This loss coverage ratio has shrunk from 100% to 16% over the past six quarters (as shown in the chart’s blue line) and needs to be built back up to a respectable level. And the only way for WFSL to build it up is to book large credit provision expenses in future income statements.

Washington Federal’s “strong” capital ratios are a function of hopeful accounting. I expect the market to come around to this view — not only for WFSL, but also for the entire banking sector. Ever since the loosening of mark-to-market accounting rules last April, the creators and users of financial statements have collectively chosen to deny reality and bury their head in the sand about the future direction of market values for collateral backing loans — and the value of the loans themselves.

Everyone is waiting and hoping for a miraculous rebound in housing prices and the labor market, when we have yet to see the bottom in either. When reality sets in, this will not end well for owners of bank stocks, REITs, and other financial stocks. These stocks are claims on assets that are marked to fantasy levels.

Mark-to-market suspension has slowed the rate at which losses are recognized, but this self-delusional accounting practice cannot make the losses disappear, and will likely make these cumulative, stretched-out losses even bigger in the future by rationing credit to the healthier parts of the economy.

Regards,
Dan Amoss

Source: GDP’s Debt to Credit

So, let’s look at techniques you can utilize to speculate in the resource exploration sector to  make unfathomable profits.

The vast majority of exploration companies are hazardous to your financial health. The key is to select only the finest companies. And in this sector, that means starting with the most talented and experienced management that are working on highly promising projects.

Your company must also be able to weather most any storm that comes its way. If I’m certain that a resource stock has the required long-term staying power I will put it in the “buy and accumulate” category.  That means I take an initial position, and then happily purchase more shares on any subsequent price weakness that has nothing to do with the company’s overall fundamentals. This is how you make volatility your friend.

You see, resource companies frequently sell off en masse. Healthy babies are routinely thrown out with the bath water. Let’s look at a stock called Impact Silver (AMEX:IPT) that is in the portfolio of my Resource Windfall Speculator service:

In this portfolio, we select stocks that relate to specific commodities that are in long term bull markets. Silver certainly qualifies on that count and we hold six total silver stocks in the portfolio right now.

To tell you the truth, Impact did not appear overpriced at the $1.50 Canadian range in early 2008. However, the global financial crash altered that perception — even though silver performed just fine last year. In fact, silver was up in 2008 and has been up nearly every year this decade. Impact silver has a 52 week high of $0.88 Canadian and a 52 week low of $0.175. How’s that for volatility?

Impact Silver has remained a buy for all of this time, because the company’s fundamentals were just fine. Their silver production and successful exploration remained on track. While the price fluctuated enormously, the value remained intact.

Again, we identify long-term value and take advantage of short-term price weaknesses when it is illogical. Anyone who had the courage to buy Impact Silver near $0.175 Canadian is pretty happy right now with its $.77 share price. That’s a 340% gain. They’ll be even happier when the company far surpasses its previous highs.

Yes, those who bought IPT near $1.50 still have some catching up to do. But that’s okay. If you want to speculate, you must be able to absorb some losses without sacrificing excessive sleep.

Another stock I personally own, Salazar Resources, has a 52 week low of $.12 Canadian and is now trading near $.80. Stock appreciations over the last eight months of 100 – 200% gains are commonplace.

The primary point is that bottom feeders can make astounding profits. We’re staring at another extreme opportunity in the coming weeks for rescuing babies from bath water.

•    Resource stocks are typically weak in late summer because the most influential players are on vacation.
•    Gold and silver get official spankings via government management with predictable regularity.
•    Resource stocks tend to sell off with the overall stock market, which now looks exceedingly vulnerable.

I’m convinced that $1,200 gold and $20 plus silver will soon be the floors under these precious metals. There will be few screaming bargains when these factors are in place. In the mean time we are probably heading for another bout of overall sector weakness that has next to nothing to do with individual company fundamentals. A banquet for bottom feeders is always a special occasion and we will be loading up in my advisory.

Are you hungry?

Invest Resourcefully,

Rusty

Source: A Banquet for Bottom Feeders

Chris, who edits the Weber Global Opportunities Report, started investing while in high school and made so much money he hasn’t had a “real” job in his life. He’s an investor’s investor. And that means when he makes a call we listen.

Chris says all the great starts of bull markets have certain things in common. And these can all be summarized with the words “Great Values.” Most important, new bull markets offer investors great dividend yields and low price-to-earnings ratio on most stocks.

Right now, the dividend yield on the S&P 500 is 2.46% — lower than the 3.58% yield the index offered was when this rally started in March.

At every start of a real bull market, dividend yields were much, much higher than just 3%. They were over 6% in 1982, over 7% in 1949, and over 10% in 1932. Those were the beginnings of real bull markets. The kind of markets that if you got in early and just held, and reinvested your great dividends, they made you rich.And that is why I have urged that everyone who participates in this rally use trailing stops. These stops can be staggered: some as low as 3%, others as high as 50%, and every gradation in between.

Yes, if the Dow reaches 10,000 or 12,500, or the S&P goes back to 1,000, or 1,100 or 1,200… there will be great rejoicing and optimism that the worst is over. But I will be looking at both the dividend yield and the price-to-earnings ratio on both indices. And from where I sit, if stocks do indeed go that high, it will only be a signal to tighten my stops. Bull markets begin with stocks trading at great values. And those values are not yet here.

Like we said before, there’s money to be made in the current rally… if you know what you’re doing. The folks at Today’s Financial News just bagged their 26th double-digit gainer since January – 30% on U.S. Geothermal.

They also see opportunity in the coming supply crunch in silver. Already, they’re up 17% on the iShares Silver Trust ETF (NYSE:SLV).

Today’s Financial News have just released a free special report featuring three undervalued silver stocks… and an options play that they think might bag gains of 1,100%. Notes readers can access it here.

And as Adam Lass points out in Taipan Daily, “for most of this year, $50/barrel has been one of those psychological ‘lines in the sand,’ much like Dow 8,000 for a while there.”

There can only be two reasons for this, according to Adam:

First of all, there is the obvious: if the global economy recovers even in the slightest, the ensuing increases in manufacturing, shipping and travel will require energy, and despite the best of green intentions, for now energy still means oil.

Second, despite all the rumblings about finding a new world currency, oil is still priced globally in dollars. And while it may be taking Washington an agonizingly long time to actually disburse all the dollars it has promised, it is finally getting around to it.

Eventually, an increase in GDP might soak up enough of those dollars to make a difference. Just as eventually my wife’s dog will grow thumbs and learn to open his own food. Could happen: he’s a pretty smart little guy and all. Still, I am not holding my breath – on either front.

Gold is also likely to benefit from inflation. What many investors – even gold bugs – don’t realize is that small gold ‘explorers’ always produce the biggest gains in gold bull markets.

But what’s really interesting is that they typically explode in price after the price of gold has already jumped. In the late 1970s, for example, the price of gold skyrocketed from around $200 in 1979 to over $800 in January 1980. But it wasn’t until after the price of gold peaked that the best exploration companies saw their biggest gains.

What kind of profits are we talking about? Carolin Mines up 1,739%; Lincoln Resources up 2,464%; Copper Lake Expl. up 13,025%; David Minerals up 1,726%; Eagle River Mines up 3,479%; Silverado Mines up 3,987%; Wharf Resources up 2,779 %

A simple $500 invested in just 11 of these companies would have given you $172,585. $1,000 invested in each would have given you about $350,000.

Mining guru and friend Doug Casey has written a special report about today’s gold exploration companies, Toronto’s Secret Gold Investment. You can get the details here.

But what most investors don’t realize is that it’s the second type of company, the small gold “explorers,” that always produce the biggest gains in gold bull markets.

These are the companies that send geologists around the world, scouring for the next gold discovery. They find a promising deposit and get samples of the rock beneath the surface using drill rigs. If the samples indicate there may be enough gold to profitably mine, they either sell the rights or do the work themselves.

What’s interesting about gold bull markets is that these exploration companies explode in price after the price of gold has already jumped.

In the late 1970s, for example, the price of gold skyrocketed, from around $200 in 1979 to over $800 in January 1980. But it wasn’t until after the price of gold peaked that the best exploration companies saw their biggest gains.

What kind of profits are we talking about?

• Carolin Mines up 1,739%

• Lincoln Resources up 2,464%

• Copper Lake Expl. up 13,025%

• David Minerals up 1,726%

• Eagle River Mines up 3,479%

• Silverado Mines up 3,987%

• Wharf Resources up 2,779%

A simple $500 invested in just 11 of these companies would have given you $172,585. $1,000 invested in each would have given you about $350,000.

Doug, who was also recently down in Buenos Aires visiting us here at Notes, has written a special report about today’s gold exploration companies, which he calls Toronto’s Secret Gold Investment. You can get the details here.

After all, this could easily just be a bear market rally. And bull markets rarely begin with a bear market rally and head straight higher.

Beware The Bear Market Trap

It makes sense to hedge against a renewed decline. Here’s why smart investors are doing so using inverse ETFs. Read on to find out what they are, how they work, and why you should consider adding one or two to your portfolio in order to protect it…

ETFs: A Safer, More Effective Way To Short The Market

Just a few years ago, investors who wanted to profit from a market/stock downturn had to borrow shares from their broker to short the asset in question. But today, betting against banks, small-cap stocks, or even entire market averages, is just one convenient ticker symbol away.

You can short the market by using an inverse exchange-traded fund (ETF).

And while I’m generally an investor who subscribes to the fact that stocks ultimately rise and produce solid, long-term gains, there are certain times when using inverse ETFs can be very appealing – particularly in the current market environment.

Exchange Traded Funds: A Brief Overview

Before we talk about the hedging advantages of inverse ETFs, let’s quickly review what ETFs are, and how they work…

• Exchange-traded funds are securities that closely resemble index funds, but are more flexible because you can buy and sell them during the day, just like common stocks.
• ETFs give investors a convenient way to purchase a broad basket of securities in a single transaction, offering the convenience of a stock along with the diversification of a mutual fund.
• From a humble start in the early 1990s, the ETF industry has exploded, particularly over the past several years. There are now over 700 ETFs, with $450 billion in assets.

And the advantages? ETFs boast several major ones over mutual funds and common stocks…

• Better diversification
• More flexibility
• Lower costs
• More liquidity
• Tax efficiency

Going Short The Smart Way With Inverse ETFs

Inverse ETFs (or short ETFs) are designed to move in the opposite direction of an underlying index. That means you profit when the benchmark tanks. The lower the underlying asset goes, the higher these funds advance.

Perfect for a bear market like this one.

Think of inverse ETFs as a type of insurance policy for your portfolio. Investing a modest amount in one of them can be a useful way to hedge against market declines, or protect your profits in certain asset classes.

And when an index or stock heads south (as we’ve seen many do with a vengeance recently), an inverse fund can help soften the blow – and in some cases, even generate enormous profits.

For example, on September 30, 2008, four days before the Dow went below 10,000, I sent a special newsflash to my ETF Authority readers identifying 14 securities that could skyrocket as the market heads south.

*Source: Bloomberg. Total returns from 9/30/08 – 3/5/09

As you can see, most of the inverse ETF have done exactly what they were designed to do in this rough market. And it doesn’t stop there…

Double Your Money with Inverse ETFs

Some ETFs can even return double the inverse of the underlying security. For example, if you buy shares of the ProShares UltraShort S&P 500 (NYSE: SDS) and the S&P 500 declines by 5%, SDS gains 10%. (Keep in mind that these funds compound daily, so if you invest for longer, the returns won’t line up exactly).

So how are these ultra-short funds able to double the inverse performance of indexes? Simple… by using leverage. The math doesn’t always work out exactly, but you can usually expect it to return double the inverse within a reasonable range.

The trade-off, however, is that these funds can be incredibly volatile – and if you’re wrong, you lose twice as much. So only consider going ultra-short if you have the stomach for it.

Why You Haven’t Missed Out on Short ETFs…

You may think you’ve missed the boat on short ETFs… but think again.

With the market coming off depressing lows, the current rally may simply be a “dead cat bounce” (which have been known to soar), as the market attempts to form a new bottom.

With this in mind, you may want to consider adding an inverse fund or two to help smooth out some of this unprecedented market volatility.

Good Investing!

Nathan Slaughter

Source: Inverse ETFs: How To Profit From The Bear Market Trap

At this point, the temptation to work as long as possible, and then blow what remains of your savings on a round-the-world cruise and a suicide pill is considerable.

However, such despair is unwarranted.

Unless you have already given up all paid employment, or absolutely have to retire in the next year or two, the current bear market may have made your eventual retirement prospects more secure, not less.

You see, the most damaging factor for your retirement happiness was not the current downturn, but the preceding decade-long bubble.

Let me explain.

Savers who devote an equal amount each month to their long-term plans benefit from an important mathematical principle: Dollar cost averaging. Under dollar cost averaging, you put in the same amount of money each month, so that amount buys more shares if prices are low than it does if prices are high.

Thus, if a mutual fund trades at $1 in month one, $2 in month two and $1.50 in month three, then a dollar-cost-averaging investor investing $300 per month will buy 300 shares in month one, 150 in month two and 200 in month three. After his month three investment, he will own 650 shares at a cost of $900, for an average cost of $1.3846. Since the average price of the shares over the three months was month three’s $1.50, he has made an extra $0.1154 per share compared with the average share price.

That’s why prolonged bull markets are so bad for retirement investors (unless they are lucky enough to retire before the bubble bursts). In this case, the Standard and Poor’s 500 Index stood at 459.27 at the end of 1994. Then after February 1995, when U.S. Federal Reserve Chairman Alan Greenspan moved to an ever-easing monetary policy with low interest rates, it took off for the stratosphere.  It passed its current level of 825 in early 1996, and except for a short period in 2002 has traded above that level ever since.

So, even though retirement savers from 1996-2008 thought most of the time that they were doing very well, in reality they were buying shares at an over-inflated price, and just about every one of their monthly contributions is currently showing a loss.

It’s not the current bear market that has caused that loss. Stock prices in 1996-2008 were always at excessive prices, so a major correction was bound to happen sometime. If the correction had happened in December 1996, when Greenspan made his famous “irrational exuberance” speech, the market would have on average been substantially lower over the subsequent 12 years. And a retirement investor who had saved over that period would be substantially richer today because he would have owned significantly more shares of the mutual fund in which he had invested.

The wise retirement savers who have a few years to go should hope the current lower stock prices stick around, maybe even go lower still provided they recover before they has to draw on the savings or convert them into an annuity. By continuing to invest regularly at these lower prices, the return from dividends and capital appreciation will compound more quickly, particularly if they buy stocks that have a substantial dividend yield.

Even if their savings remain adequate, they shouldn’t convert them into an annuity because annuity rates are currently very low. With long-term Treasury bonds yielding less than 3%, actuaries factor that exceptionally low return into their annuity calculations.

Right now, a 65-year-old man who buys an annuity can expect to receive only around $74 per $1,000 of investment, without any protection for inflation or guaranteed minimum return if he dies quickly. Once interest rates rise, as they are almost bound to, that annuity rate will rise in step with them.

Rather than convert into an annuity, the retirement saver should simply invest in stocks that are both solid and yield more than 7.4% – and there are still plenty of them out there. That way, he can achieve the same return as an annuity while preserving, and maybe even increasing, his principal – in addition of course to any further monthly payments he can make while still working.

By building a portfolio of such stocks including a selection from emerging markets, he can take advantages of the higher-dividend payouts frequently found outside the United States.

Finding stocks with dividend yields equal to or greater than an annuity yield was tough when the S&P 500 was at 1400. But at 800, it’s a lot easier, even if you want to avoid the financial sector for obvious prudential reasons.

Such solid companies as General Electric Co. (GE), BP PLC (ADR: BP), Du Pont (DD), Newell Rubbermaid Inc. (NWL) and Limited Brands Inc. (LTD) yield well over 7% currently, and that’s without venturing into emerging markets companies.

If your retirement portfolio has been decimated, don’t despair. At these lower stock prices it will be much easier to build its value up again, and because stock yields are higher you won’t need so much capital to generate the income you want to live well.

Source: Retirement Investing: How Bear Markets Can Help Your Retirement Planning

Why a Jim Morrison market? Because the future’s uncertain and the end is always near.

(I thought that was too good not to share. For those of you who aren’t fans of The Doors, we’ll move right along…)

Something’s Happening Here…

Something very strange is going on with the price of oil. Not just in terms of straight-up price, but in regard to the huge discrepancy between the near-month and far-month futures contracts.

As I write, the going price for near-month West Texas Intermediate crude is $36.51 per barrel. The December 2009 contract, on the other hand, is trading at $55.13.

That is a monster spread. We’re talking a difference of more than $18 a barrel between spot crude – the stuff you can buy in the cash market – and crude slated for delivery at the end of this year.

The technical name for this situation is contango. That’s what they call it when a forward-month commodity contract is trading at a higher price than the near month. (You don’t really need to know this right now, but the opposite of contango, when near-term prices are higher than the back months, is backwardation.)

The reason this is strange is because of the massive profit opportunity embedded in the crude market.

Assuming you had the means, you could go out right now and sell millions of dollars worth of December crude contracts at $55 dollars a barrel… buy the equivalent amount in the cash market for $37 a barrel or less… and then just wait until it’s time to deliver the oil (and lock in your $18 profit).

The only hitch in the deal is finding a place to store the stuff. If you were to buy crude on the cheap now, you would have to take delivery and store it until late November (or whatever month your delivery date rolls in, when you close the trade and take your locked-in profit).

A number of big, savvy players are making exactly the trade I just described. They are selling millions of barrels worth of expensive far-month futures contracts, buying the equivalent amount of cheap oil in the cash market, and storing that oil in huge supertankers moored off the coast of Scotland and the Gulf of Mexico.

Storage and financing are counted as part of the trade, of course, and those big tankers don’t come cheap. Costs can run as high as $68,000 per day to keep one sitting idle.

But when you can lock in $18 a barrel, who cares? When the outlays are spread over millions of barrels – and a single ship can hold 2 million barrels of crude – there is still an obscene amount of profit left in the trade.

Frontline Limited (FRO:NYSE), the world’s biggest owner of supertankers according to Bloomberg, estimated last week that 80 million barrels worth of oil are being “stored” this way – the most they’ve seen in 20 years.

Not only are some big Wall Street players making this trade (Citigroup, Morgan Stanley, etc), big oil exporters are doing it too. Iran is filling up tankers with crude, no doubt waiting for the opportunity to sell at higher prices.

What It Is Ain’t Exactly Clear…

The puzzling question is why the anomaly persists. Why has the spread not come in?

Remember that once the far-month contracts are sold, price risk is removed from the equation. If you’ve entered into a deal to sell 2MM barrels of crude at $55 after buying at $37, you don’t have to worry about where prices go between now and your delivery date. You can just sit and wait.

When a no-brainer opportunity like this comes along, Wall Street normally jumps all over it. Traders exploit the anomaly in size until it disappears.

If markets weren’t so out of whack, you would gradually see the spread between near-month and far-month crude contracts get smaller and smaller as more and more players piled in. The profit in the spread would be reduced to the point where putting on the trade no longer made sense.

Two constraints that keep this from happening now are financing and storage.

First the finance angle: This is a trade that requires a serious cash outlay (or a major line of credit) to pull off. To fill up a supertanker with crude and sit on it for a year, you’re talking $50 million to $100 million as table stakes. The big Wall Street houses have been so bruised and battered, it’s hard for them to come up with that kind of dough – even for slam-dunk opportunities.

The other major constraint to the trade is storage. Such huge volumes of cash market crude are being held off the market now, traders are literally running out of places to put it. (It’s not like you can just pop into the local EZ-storage or stash a million barrels of oil in the shed.)

Curiouser and Curiouser

The storage issue is also creating headaches for the New York Mercantile Exchange (NYMEX) as traders question the pricing of West Texas Intermediate (WTI crude). The Financial Times reports:

The surge in oil inventories in Cushing, Oklahoma, where WTI is delivered into America’s pipeline system, has depressed its value not only against other global benchmarks, such as Brent, but also against other domestic US crudes.

Julius Walker, an oil market analyst at the International Energy Agency in Paris, said there was “anecdotal evidence” of traders moving away from WTI and “doing deals based on other US oil benchmarks.”

In other words, we’ve got oil coming out of our ears in the short-term… but the price of oil is still head-scratchingly higher – much, much higher – in the longer term.

So what does all this mean for us small-fry traders, i.e., those of us who can’t dial 1-800-TANKERS-R-US like the big boys?

I can think of at least a few takeaways worthy of food for thought:

• Why aren’t the big oil exporters all over this trade? Iran has locked up a few tankers, and it’s likely Russia and Venezuela etc. have too. But these guys are supposed to have lots of oil in the ground… and OPEC just made a big fuss of capacity cuts…. so why aren’t they selling the hell out of the far-month crude contracts, locking in $18 a barrel, and bringing the spread back in with their size? Could it be capacity constraint? Could it be these guys don’t actually have all the spare capacity they’re letting on?
• Why are the drillers and oil service names so depressed? Stock markets are supposed to discount the future, not the past. Equity valuations are supposed to be forward looking. And yet, at current multiples, most of the high-quality drillers and oil service names are trading as if oil were headed to $20, not back to $60. Yet the December crude contract says otherwise… and the huge spread between near-month and far-month contracts persists. What gives?
• Could Wall Street still be “broken” in the aftermath of 2008? After the year we just went through, anyone who still believes in perfectly efficient markets should have their head examined. Markets operate in a range from “mostly efficient” to “wildly, insanely INefficient.” When credit mechanisms and normal channels break down, things just stop making sense. Could the huge disconnect between forward-month oil contracts and insanely cheap oil service names be yet another example of Wall Street not making sense?
• Could December crude contracts be expressing an opinion on the inflationary effects of U.S. debt monetization…. or rebound possibilities for emerging markets…. or both? It’s widely recognized that the U.S. Fed and Treasury are embarking on a “great experiment” now that has never before been tried – one that could be summed up as, “Print like crazy and see what happens.” Some observers, like Joachim Fels of Morgan Stanley’s Global Economics Team, further believe that emerging markets could outperform in 2009 due to better internals than they get credit for. Could the persistent crude spread be reflecting both views?

Yep, no question… something’s happening here. I’ll stay on top of things and keep you posted. If an opportunity arises in the drillers or the oil service names, or in crude itself, you can be sure we’ll be exploiting it to the fullest via Macro Trader.

And by the way, another great thing about Taipan Daily is the largely untapped resource of reader knowledge… so if you have any ideas or insights on this “crude conundrum,” I’d love to hear from you: justice@taipandaily.com.

Source: Something’s Happening Here with the Price of Oil

I’ve been covering the Pilbara and its huge iron ore deposits since moving to Australia three years ago. I consider the place ground zero in the resource bull market. Like most bull markets today, the Pilbara’s boom is related to Australia’s neighbor to the north, China. China is consuming iron ore, coal, natural gas, copper, zinc, and crude oil at a pace we’ve never seen before in human history.

Most of us know China’s boom is a huge driver in the bull market in infrastructure, energy, metals, and minerals. But there’s another developing region you’ve probably never considered… one that could make you a rich investor over the coming years: the Middle East.

The Economist reports the six nations of the Gulf Cooperation Council (Saudi Arabia, Kuwait, Bahrain, Omar, Qatar, and the UAE) earned $381 billion from oil exports in 2007. The cumulative earnings will reach into the trillions if oil remains over $100 for several years. The region literally has more money than it knows what to do with. A lot of that money is flowing into infrastructure.

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From Dubai to Kuwait, there’s an estimated $2.4 trillion in construction projects either underway or in development in the world’s biggest oil patch.

Surprisingly, $1.4 trillion of that total is for projects in civil construction. This means spending on residential and commercial construction projects in the Middle East outweighs construction on oil, gas, power, petrochemical, industrial, and water projects combined.

The three largest civilian projects are:

1. King Abdullah Economic City, Saudi Arabia: $120 billion. The leading firm is Dubai-based developer Emaar.

2. Silk City Project, Kuwait: $86 billion. The leading firm is Tamdeen Real Estate.

3. Dubailand, UAE: $60 billion. The leading firm is Tatweer.

The Saudi Arabian government wants to diversify the Saudi economy from its current “Three Pillars” strategy of oil, petrochemicals, and industrials. This building strategy is just one of the forces driving up steel prices, which are now over $1,000 a ton.

The Saudis know their 262 billion barrels of oil reserves won’t last forever. They are attempting to plant the seeds for self-sufficient regional growth that’s not related directly to the oil economy. This means building six brand new cities as centers of commerce and enterprise.

That’s right… They’re building giant new cities out of nothing. Four have already been launched. They are:

1. King Abdullah Economic City
2. Jizan Economic City
3. Knowledge Economic City
4. Prince AbdulAziz Bin Mousaed Economic City

Whether the Saudis can build economic prosperity from nothing is an open question. They certainly have the capital to try. High oil prices have guaranteed that.

From an investment perspective, the long-term success of the Saudi’s grand economic strategy doesn’t matter. The money is going to be spent. Any sensible investor, seeing such gaudy capital expenditure figures, would do the only sensible thing: follow the money.

It is not just Saudi money either. And it is not just residential and commercial growth. A lot of it is industrial, petrochemical, and power related.

For example, in the United Arab Emirates, Dubai recently announced plans to build the world’s largest aluminum smelter ever. It’s a $5 billion project with the aim of producing a smelter that can generate 700,000 tons per year. Saudi Arabia has plans for its own $3.8 billion aluminum smelter. Oman has plans for a $2.2 billion smelter.

That’s $11 billion for just three projects.

How can you profit from all this? As I’ve written in my previous columns, the global building boom is going to require awesome amounts of iron ore and base metals… so producers of this “stuff” still have years of gains ahead of them.

You can also buy engineering and construction firms. Someone has to receive the contracts to build all of this stuff. Go through the holdings of the PowerShares Building & Construction ETF for some ideas.

Whichever investments you choose… realize the infrastructure boom isn’t just focused on China. The U.S. is spending to upgrade its “F” infrastructure rating. Russia is spending. Latin America is spending. And now, the Middle East is spending its oil money. It all points to big returns in infrastructure stocks.

Good investing,

Dan Denning

Source: How Arabs Will Drive the Next Great Infrastructure Boom